LP Perspectives in the COVID-19 Environment

EisnerAmper’s 5th Annual Alternative Investment Summit

EisnerAmper’s 5th Annual Alternative Investment Summit 2020: A Year of Change featured a session where panelists discussed investor considerations when allocating to private equity. During “LP Perspectives in the COVID-19 Environment,” the speakers concurred that despite a slowdown in fundraising and deal-making during Q1 and Q2 of 2020, private equity has largely retained support from limited partners (LPs), evident in the minimal amount of defaults on capital commitments.  With the global pandemic expected to continue for the foreseeable future, it’s critical for firms to retain their LP base as a solid source of liquidity and to understand their perspectives and outlook over the next several months. The panelists included:

• Jennifer Choi, Managing Director of Industry Affairs, Institutional Limited Partners Associates (ILPA)
• Wes Bradley, Senior Portfolio Manager, Florida State Board of Administration
• Marci Haydel, Managing Director, Performance Equity Management

Moderated by Anthony Minnefor and Irina Gershengoren, Partners, EisnerAmper

Here were a few themes discussed that LPs should consider:

MARKET SWINGS

In March 2020, the outlook on the market was rather bleak, but since then things have bounced back pretty quickly.  For LPs to default on capital calls, there would need to be a substantiated downturn between six and 12 months, similar to the 2008 global financial crisis; but with COVID-19 the rebound was so quick that it didn’t impact LP liquidity.  Additionally, LPs are sophisticated and have learned from the global financial crisis to put in place measures of flexibility in how they manage their allocations and liquidity, such as establishing their own lines of credit to insulate themselves from the liquidity pressures of forced selling in a down market.

NEW COMMITMENTS

The risk, however, will be with new commitments and the type of LPs in the fund.  Each type of LP has a different counterparty risk.  Hospital systems and health care and university endowments faced a lot of pressure when COVID-19 hit because of decreases in revenues and colleges canceling fall sports. With tax revenues down, state pensions will suffer, which will affect each of their future commitment decisions.  This will be especially challenging for new managers looking to raise capital in the current environment, which has forced people to work from home.  While virtual meetings have given people the opportunity to meet “face-to-face,” it is more difficult to create a rapport and make a long-term commitment without meeting in-person.  

SUBSCRIPTION LINES OF CREDIT UNDER SPOTLIGHT

On the fund side, subscription lines of credit have received more attention recently.  Historically, subscription lines were used primarily by general partners (GPs) to limit the frequency of capital calls or, in the distressed space, to take advantage of investment opportunities where they might not have the time to call the capital.  More recently, they have been utilized to minimize the J curve and give a boost to the fund’s internal rate of return (IRR).  This has become more widespread as GPs look to keep up with their competitors and not be artificially pushed down the benchmark standings simply by virtue of the fact that they’re not doing what everybody else is doing. 

Subscription lines of credit have also raised concerns among LPs.  At the onset of COVID-19, LPs were concerned that in a liquidity crunch, all of these subscription lines were going to get paid down at once and they were going to be forced to satisfy far more capital calls than modeled for.  LPs are also faced with a challenge in evaluating performance as the benchmarks don’t distinguish between a fund that uses a subscription line and a fund that has traditionally timed capital calls.  LPs are asking for more transparency in how these subscription lines are being managed and their impact on reporting IRR.  They are requesting, or in some instances inserting a requirement in their side letter, that the GP provide IRR on a leveraged and unleveraged basis.  In the financial statements, they are expecting to see the terms of the facility including the size, amount outstanding in relation to their unfunded, duration and interest rate of the subscription lines which will allow them to calculate their total exposure and get a true picture of what they have on the ground. 

While some of the concerns of LPs at the onset of COVID-19 haven’t yet come to complete fruition yet, the global pandemic is still ongoing and these will continue to be their top of mind considerations.

You can view the panel here.