Top Five Private Capital Investor Concerns

March 9, 2018  | by Ralph P. Money, Peter Burns

Industry Knowledge | Investment Strategy | Private Capital

At the end of the year we sent out a short survey to learn more about investors’ headline concerns about the private capital markets today. Investors also shared their expectations about returns and where they see their allocations to various private strategies trending.

Headline Concerns

(The top five industry concerns, in rank order)

1

“Prices are getting frothy” (the valuation uptick of purchase price multiples being paid in some sectors, strategies and regions);

2

Fees/terms (the general direction of fees, expenses and alignment becoming more balanced between GPs and LPs);

3

“Growth of fund sizes” (the overall increase in fund sizes from one fund to the next in some segments);

4

“Capital overhang” (the amount of committed capital but not yet invested, especially in the large end of the market); and

5

Difficulty in accessing top funds (quality matters and can help drive success).

We agree with these industry concerns and others raised in the survey and take them into account every day in how we design and build investor portfolios.

Our Perspective on Each Shared Concern

Pricing

Like the public equity markets, increased valuations in some private capital sectors cannot be denied. This requires us to “pick our spots”, especially in areas where we see relative value and tilt our investment point of view, accordingly. In venture capital, for example, we prefer early stage, rather than later stage investments, where industry valuations have increased.

Fees/Terms

Private capital is expensive – but we believe worth it when you can access and work with industry leaders to achieve a goal of the three percent premium over the public markets over the long term. That said, to help drive returns and to lower the overall fees paid to managers, we continue to favor increased allocations to capital efficient strategies, such as secondaries and co-investments. We continue to evaluate managers on their “net” results — and for some premium managers that we partner with, we believe premium fees are worth it on a net return basis.

Growth of Fund Sizes

Generally we believe that investors should tilt their commitments towards smaller and medium-size sector specialists that focus on investment success as their primary wealth creation driver (as opposed to fee revenues generated on large fund sizes). Many of these smaller firms are capacity constrained and tough to access. It is our view that researching and accessing a basket of smaller firms and sector specialists makes for a robust portfolio — especially when complemented with secondaries and co-investments alongside high conviction managers. We believe the labor involved to network, source and research such managers can lead to compelling portfolios and results.

Capital Overhang (or “Dry Power”)

We, too, are keeping a close eye on the so-called “capital overhang” — especially in the large end of the market that dominates the “dry powder” in the industry. The smaller and mid-size segments represent a smaller share of the overhang. In past cycles, the “relief valves” for such overhangs have been driven by new investments and follow-on investments into portfolio companies. We also have witnessed larger firms buying small and mid-size portfolio companies held by the smaller and medium size managers.

Access

Accessing the best managers requires hard but critical work. For three decades we have promoted three key principles of private capital investing:

Dollar-cost average across vintage years and cycles — and do not try to market time;

Diversify across:

  • Private strategies — venture capital, private equity and natural resources;
  • Geographies — US, Europe and other developed markets (like Japan and Australia) and select emerging markets (like China, India, and parts of Latin America, Central and Eastern Europe and Africa); and, most importantly;
  • Focus on accessing quality managers.

Research and access best of class quality managers to build portfolios around the “best” versus the “best available”.

We believe that institutional investors that are charged with achieving CPI + 5% returns to sustain their missions, or to meet their spending objectives must use their size and long-term investment horizon to their advantage. A disciplined and consistent program of including private capital investments in the portfolio to capture the premium that they can offer over public equity markets can be an important contributor to these pursuits.

Authors

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Peter Burns is the President & CEO of Commonfund Capital. His responsibilities include oversight of due diligence, manager selection and investment management for the firm’s private capital Primary, Secondary, Co-investment, and Distressed capital programs. Peter is a member of the Investment Committee of Commonfund Capital and member of the Operating Committee of Commonfund. He has 27 years of investment, corporate finance, and lending experience. Prior to joining Commonfund, Peter worked as a Vice President of Taglich Brothers, a New York-based investment bank and brokerage firm. Prior to this, he was an associate in the Leveraged Funding Group of Heller Financial. He is presently a member of the advisory boards of several private capital limited partnerships. Peter received a B.A. in Economics from St. Lawrence University and an M.B.A. in Finance and Marketing from Columbia Business School.
Peter M. Burns
President & Chief Executive Officer, Commonfund Capital
X
Ralph Money is Head of the Investor Relations team at Commonfund Capital. He is a member of the investment team, senior product specialist and serves as the team’s lead limited partner contact. Ralph has over 30 years of experience in investments, investor relations, nonprofit financial and general management and institutional banking. Prior to joining Commonfund Capital, he worked with Commonfund Securities, Inc. serving the investment management needs of institutional investors primarily in the northeast. Prior to joining Commonfund, Ralph held various leadership positions within foundation and mission-based organizations including the American Red Cross. His responsibilities included setting strategic directions, financial and investment management, advancement and resource development. Ralph also spent four years at the Chase Manhattan Bank as an officer responsible for covering financial institutions in New England and the Midwest. He has served on the advisory boards of several private capital limited partnerships. He currently serves on the investment committee of the Northfield Mount Hermon School. Ralph has served on the boards of directors of several social sector enterprises and is the former ranking member and chairman of the fire commission in Fairfield, CT, past chairman of the Investment Committee of The Unquowa School and is a former member of the Police and Fire Retirement Board for the Town of Fairfield. He received a B.S. in Business Administration from Georgetown University and has an M.B.A. from Harvard Business School.
Ralph P. Money
Managing Director
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Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.