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Fund Performance

LPs prioritize performance to stick with top-quartile managers

With a tightened exit environment and limited distributions, LPs prefer top-quartile funds over middle-tier and emerging managers.

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Limited partners are in the midst of top-grading their portfolios—another hit to the fundraising efforts of firms that fall below the top quartile.

As 2023 comes to a close, LPs are evaluating their allocations and filtering relationships with managers based on performance. They’re reluctant to commit and recommit to those with underperforming funds, preferring top-quartile vehicles over middle-tier, and emerging managers.

GPs with the highest conviction from LPs will command the bulk of the fundraising dollars, said Matt Bank, deputy chief investment officer at Global Endowment Management, which invests on behalf of smaller endowments and foundations.

“The marginal manager, especially in venture but in other areas too, is going to have a harder time raising capital than he or she once did,” Bank said.

LPs tend to be more willing to use their limited pool of capital to reinvest with known GPs before making commitments to new ones.

Even so, in the current environment, there’s no guarantee that LPs will invest in their current managers’ subsequent vehicles. The decision depends on the fund’s past performance and future return projections, said Alex Russ, North American head of Evercore’s private funds group, the firm’s placement agent.

“The bar is higher than it’s ever been there, given how competitive the slots are for capital,” he said.

From 2021 to the end of 2022, PE’s first-time fundraising activity fell 11.4%, according to PitchBook’s Q2 2023 Global Private Market Fundraising Report.

“The number of first-time funds is way down,” said Kevin Kuryla, global head of UBS’ private funds group, which advises asset managers on fundraising. “You either have to have a fantastic track record and reputation or you have to be super brave.”

LP’s top-grading activity is critical for an asset class with high performance dispersion. In PE, there was a 17.27 percentage-point difference between the performance of the top and bottom quartile vehicles with 2005-18 vintages—the largest gap between the top and bottom performers of any asset class other than VC, according to PitchBook’s Q1 2023 Global Fund Performance Report.

Performance dispersion is particularly acute during a fundraising squeeze.

In 2022, LPs grappled with the denominator effect, which left institutions overallocated to the private markets. As institutions work to rebalance portfolios, the amount of capital LPs have freed up to put to work with new commitments is constrained.

“2022 was the most challenging primary market we’ve seen in the past 14 years,” said Russ.

As a result, GPs extended their fundraising timelines. In 2022, the average time to close a buyout fund in the US was 16.1 months, the longest since 2009, according to PitchBook’s Q3 2023 US PE Breakdown.

While the denominator effect has subsided this year, LPs are still holding their capital close to the chest.

“They’ve seen the fundraising timelines slip,” said Russ. “They’ve seen the headlines about brand-name, large-cap sponsors reducing their fund cap targets, and they know that they’re in the driver’s seat.”

Featured image by Tim Grist Photography/Getty Images

  • jessica-hamlin-headshot.jpg
    Written by Jessica Hamlin
    Senior reporter Jessica Hamlin writes about limited partners for PitchBook News, based in New York. Jessica is also the lead writer of the Capital Pool weekly newsletter. Previously she wrote about private equity for Institutional Investor in New York. Jessica is a graduate of the Grady College of Journalism and Mass Communication at the University of Georgia.
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