Before the Covid-19 pandemic, mega buyout managers around the world were closing record-sized funds with little trouble. Data from Preqin and Bain & Co shows that although the median size of closed buyout funds almost doubled between 2014 and 2019, the number of fund closes over the same period dropped by almost a fifth. Big funds have been very much the flavour of the month.

The accelerating spread of the pandemic has, of course, changed fundraising dynamics altogether, with the denominator effect and movements in portfolio valuations having a direct impact on LP appetite and strategy.

Despite these difficulties, some large-cap managers have continued to test the market. Are LPs still willing to write large cheques in an uncertain market? Does the large-cap model still appeal? What are LPs looking for from managers in a post-COVID world?

In a recent Real Deals podcast, MVision’s Mounir Guen and EQT’s Jussi Saarinen shared their thoughts on the dynamics around mega-funds in a post-COVID market. Here are some of the highlights

Listen to the full recording here

Mega-funds: a harbour in the storm

Guen said that the fundraising market was already shifting before the spread of the pandemic started to accelerate.

“Before Covid-19, GPs and investors had a mindset of expecting some kind of correction. Their were concerns around trade talks and political changes, so there was already the view building that the music had to stop at some point,” Guen said.

Investors, therefore, had already put together defensive portfolios, which meant going long on the US dollar and heading for a safe pair of hands. Large managers were ideally placed to meet these demands.

“The large firms have been able to demonstrate a concept of principal protection, consistent performance and ability of deployment. They also offer very good co-invest, so by default they are the natural go-to because other parts of the market have greater volatility,” Guen said. 

Fundraising markets: then and now

When comparing the fundraising market pre- and post-COVID, Saarinen said that biggest difference to the fundraising market since the pandemic was simply the restriction on meeting investors in person.

“This has implications for the speed of fundraisings, but even more importantly, the ability to attract new investors. It is hard to build relationships over the phone. You need to meet physically,” Saarinen said. “With existing investors, who already know you, you can manage with video, phone calls and email. But when it comes to new investors it's very tough.”

Guen added that although personal interaction had been restricted, the pandemic had actually provided the opportunity for more communication between managers and investors. Time travelling had been reduced significantly, providing opportunities for investors and managers to connect more often via calls and video conferences.

“Communication has improved and governance has tightened even more… the private equity community has really looked at what it could do better and responded quickly to the challenges posed by lockdowns. From my point of view, I see very good performance across the industry,” Guen said.

Adapting to larger funds

Increasing the size of funds over time is a mark of success, but also comes with challenges as managers have to find ways to deploy larger amounts of capital effectively.

Saarinen, however, said EQT had been able to grow its AUM without drifting away from the part of the market where it had built its track record. Investing in its key infrastructure and rolling out effective deal strategies in new geographies had allowed the firm to expand without losing sight of what had brought returns in the past. “Even though we have increased our fund sizes quite significantly over the past 15 years or so, we haven’t really changed the target portfolio size,” Saarinen said. “When it comes to sourcing, nothing has really changed in terms of approach, but we have been continually investing in our platform and our industrial advisory network.

"We have also expanded geographically, slowly but surely and ‘local with locals’ has been a very important part of our investment thesis.” Guen said the tipping point in target company size typically occurred when managers that had started out with €350m, broke through the €2bn fund size threshold. Even in these circumstances, however, most managers tended to do more deals rather than writing bigger cheques.

“The sweet spot of a firm actually stays pretty consistent even though the pools of capital get larger. Also, you mustn’t forget that these larger funds offer a fair amount of co-invest to their investor community, so they are actually deploying quite a lot of capital,” Guen said. He explained that COVID had also influenced the way GPs had thought about digitalisation across their portfolios, which had helped many private equity-backed businesses to rebound after the initial period of uncertainty.

Deployment is key

Guen said that in addition to returns, large institutional investors were also leaning towards managers who could maintain consistent deployment at a time of low-interest rates.

“Large investors do need to secure a risk-free rate of return of around 7 per cent and it is hard work to get there. The alternatives space offers that type of profile they need to meet the objectives of their long term capital,” Guen said. “That means that deployment is critical...The impact of COVID isn’t necessarily within the return profile in my view, but whether the GP can keep deploying the capital.”