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How to navigate fund performance in a changing economy
Limited Partners

How to navigate fund performance in a changing economy

Learn how LPs are navigating changing market conditions with new tools and resources for stronger portfolio allocation.

It can be difficult for limited partners (LPs) to find the right balance of risk and return in their portfolios. In fact, many allocators have now realized they can no longer rely on outdated methods of analysis, which can lead to inaccurate cash flow projections. As the private capital markets continue to evolve, LPs must also adapt their allocation strategies to ensure their fiduciary responsibilities are met.

In this blog post, we’ll explore how LPs are navigating changing market conditions with new tools and resources for stronger portfolio allocation. While we believe a soft-landing scenario is increasingly likely, there is still a high chance of a US recession—making this an opportune time to revisit your portfolio construction.

Understanding the LP Landscape

In order to achieve their beneficiaries’ goals, LPs allocate capital into the private markets—working with general partners (GPs) that manage funds in return for a percentage of profits. In some cases, they may also invest through the public markets or via direct, secondary, and co-investments in the private markets. Either way, the challenge lies in deciding what to invest in—and who to invest with.

From private equity to venture capital, private debt, real estate, funds of funds, and more, LPs have their choice of strategies—each of which comes with a different risk/return profile. Even within a particular strategy, there can be a huge difference in individual fund performance. How then can allocators understand which strategies—and fund managers—are right for their portfolio at any given time?

To make informed investment decisions, allocators need a full view into the private markets. This means understanding macro-level trends, as well as key metrics such as deal volume and values within specific asset classes.

Q4 2023 PitchBook-NVCA Venture Monitor
There’s no question that VC has had a tough 12 months. But despite the $71.6 billion less capital invested in the asset class than in 2022, sunnier skies are ahead.

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The shifting interest rate landscape, along with slow distributions recently from existing funds, has many allocators thinking about their allocation budgeting for private markets going forward. The playbook has changed, so it's important to be armed with robust frameworks, data, and analytics to set up portfolios for long-term success.”

Zane Carmean, Lead Analyst Quantitative and Funds Research 

Allocator workflow optimization

Starting from the top, allocators need to first create and follow an Investment Policy Statement (IPS). This document describes beneficiaries’ objectives and sets clear expectations for how capital will be managed within their portfolio—including guidance around investment strategies, timelines, fund manager selection, and performance benchmarks. Once this document has been created, LPs then need the insights to execute it with confidence.

If you’re looking to optimize your workflows across strategies, here are a few considerations:

Sourcing high-caliber fund managers with due diligence

Fund manager selection is a crucial step in the allocation process, as it can have an outsized impact on your portfolio returns. Even within the same strategy, one manager might outperform another for a variety of reasons—including the strength of its team.

With this in mind, explore data on historical performance—as well as investment style and preferences, fund performance benchmarks, contact information, and background details on key personnel.

If it’s helpful, you can use our screeners to identify potential GPs that match your high-level investment strategy, then dive into more detail as needed.

Once you have put together a list of potential fund managers, you can then do your due diligence—digging into individual profiles to narrow down your options.

Contextualizing fund performance in shifting markets

Ideally, you should understand benchmarks prior to actually investing. If a fund manager’s performance is not up to par, you’ll need to do some more research to understand why. There could be many factors at play—and as our analysts have found, past performance is not necessarily a good predictor of future performance. Here are a few considerations for your analysis:

  • Look at public market performance to see if the fund you are evaluating measures above that baseline
  • Compare two funds within the same vintage year to better gauge relative performance
  • Consider the realized versus unrealized Net Asset Value (NAV) within that fund, and how the math may change once distributions start coming in

The problem is that many allocators do not have access to custom benchmarks, and lack full insight into the actual data behind closed-end funds. If you want to make more accurate comparisons, you need a reliable and transparent way to view trends in fund performance.

PitchBook Benchmarks (as of Q2 2023)
PitchBook Benchmarks offer a window on the latest data for closed-end fund returns across strategies and vintage years. The new edition is now available, updated through Q2 2023 with preliminary data for Q3.

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Asset allocation and investment decisions

It’s worth noting here that asset allocation is an ongoing process. There could be certain times of the year when your team might, naturally, take a step back and reevaluate your current portfolio.

For instance, if you tend to work on an annual basis, you might look at how much capital is allocated to each asset class starting in January, when you’d have access to the latest data for the past few quarters. Among other metrics, you can look at IRR and cash multiples, as these benchmarks can provide context across strategies and vintages.

Liquidity events are another important factor, although it can be difficult to predict how much cash you’ll have access to at any given time. If you’ve ever experienced an ill-timed capital call or had to wait longer than expected for a distribution, you know how stressful this can be.

If you are hoping to optimize your returns, you need to find the right mix of investments that will reflect your needs—not only today, but also five, or ten years down the road. This is when cash flow forecasting can come in handy.

Risk management strategies

After you’ve made your initial investment decisions, the work isn’t done. Let’s consider how you might adjust your portfolio to accommodate newfound risks and opportunities. Some LPs have strict mandates, while others can build more flexible portfolios. Either way, today’s allocators are looking more closely at the risk/return tradeoffs:

  • Is it still worth investing in riskier opportunities if they are not needed to meet your targets?
  • What opportunities might you potentially be sacrificing if you opt for a higher proportion of illiquid investments?

As PitchBook’s analysts have recently noted, the allocators’ playbook has changed. To build a portfolio with a 7-9% target return in a low interest rate environment, allocators were forced to take on more risk. Recently, however, cash and core bonds have become more attractive on a relative basis.

That said, every allocator’s portfolio will look a little different, depending on their risk tolerance.

A tool like Portfolio Forecasting can help you more confidently forecast the cash flows of private market funds and develop a commitment schedule to achieve your target allocations.

Rather than relying on simple spreadsheets and back-of-the-envelope math, you can leverage more nuanced cash flow models to ensure you keep the right amount of cash on hand. Build sample portfolios using PitchBook’s data—or upload your own funds to create a model that aligns with your current strategy.

Tracking and evaluating fund managers

The average LP-GP relationship is long-lasting—and a lot can change in the span of 10-15 years. When it’s time for a re-up, how will you know whether you should continue working with a particular fund manager?

There is something to be said about building trust with your existing GPs. If you are happy with how they have demonstrated value and believe they will continue to do so, that’s certainly a strong signal. However, given how large the fund landscape has grown in recent years, we would encourage you to consider your options.

Manager Scoring enables limited partners to quickly evaluate fund manager performance. Simply search for your fund manager—then see how their score compares relative to peers. For instance, do they distribute capital faster or slower than similar managers?

Macro analysis and allocation strategy validation

To better anticipate potential returns, allocators need to stay current on the broader macroeconomic landscape and state of the private markets.

To give a recent example, the denominator effect impacted many investors’ portfolios, as LPs found themselves suddenly overallocated to the private markets. Then in 2023, when public markets began to rebound, the exit environment did not. This created a new portfolio management problem. In a slow distribution cycle, diversification becomes even more challenging, as allocators lack the liquidity to make new commitments.

With access to in-depth private market data and analysis, you can more clearly determine the best path forward. Questions to consider include:

  • What percentage of your portfolio should be dedicated to private versus public markets?
  • Would it make sense to invest more heavily in an alternative asset class, such as real estate or venture capital, in lieu of stocks and bonds?
  • Does your current portfolio strategy still align with your beneficiaries’ risk/return profile—or do you need to reallocate assets in light of changing conditions?

Of course, there is no right answer to any of the above, as every LP will have a different allocation strategy. However, we hope our analysts’ expert commentary on various asset classes can help you understand key trends, so you can adjust your strategy as needed. Think about it this way: The more informed you are, the easier it should be to position your portfolio for success in a changing economy.

About PitchBook for Limited Partners

PitchBook is designed to help LPs through every step of their workflows—from market research to fund manager evaluation, allocation, and risk management.

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