LPs wary of shadow capital impact

Limited partners are concerned that the rapid growth of shadow capital will impact returns generated by traditional funds, according to a new report by Coller Capital.

In the latest edition of the Coller Capital Global Private Equity Barometer, which surveyed 110 investors, almost two-thirds said that they expect the growing popularity of co-investment, direct investment and managed accounts to exert downward pressure on private equity fund returns.

LPs are also worried about heightened competition and increasing fund sizes, with 88 per cent and 86 per cent respectively listing these factors among their concerns, and 69 per cent acknowledge that investment decision making is becoming “inherently harder” due to the unpredictability of today’s global economy.

However, despite these issues, private equity’s appeal among investors remains strong. Almost 90 per cent of LPs have achieved net annual returns of at least 11 per cent, and more than one-third plan to increase their allocation to the asset class in the coming year, with just four per cent intending to cut back. 

This is in stark contrast with the attitude towards hedge funds – 26 per cent of LPs are planning to reduce their hedge fund activity, with only eight per cent increasing.

“We’ve always known private equity is a long game. This trend of increasing allocations to private equity which we’ve seen in previous barometers is continuing, partly driven by good performance,” says Stephen Ziff, partner at Coller Capital. “LPs are not changing the pace of their commitments despite market volatility, they are riding out that volatility. The performance of private equity has been borne out in the long term.”

In fact, almost 60 per cent of LPs report that they are struggling to commit at scale to their target GPs, a factor which has contributed to the growth of shadow capital. The problem is particularly acute among mid-sized LPs – 88 per cent cannot deploy in their desired amounts.

“You have the smaller LPs that are nimble and agile, you have the larger ones that have sufficient capacity and clout – it is the squeezed middle, those in the £5bn to £10bn range that are struggling to secure access to their preferred GPs,” says Ziff.

Elsewhere, there is further positive news for GPs. Two-thirds of investors believe that private equity’s reputation is good or neutral, compared to just over half in 2012. Some 44 per cent say that its image is worse than it deserves, while fewer investors are concerned about fund terms and conditions and succession issues than three years ago.

“There has been a shift from structural to cyclical issues within private equity. It does suggest that some of the issues around fees, terms and succession have been addressed,” says Ziff.