LPs pull back from first-time funds

A liquidity squeeze and ever-larger fundraises from established rivals have created a difficult environment for emerging managers, but optimism remains

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LPs have remained reticent about investing in first-time funds over the last year, as increasingly challenging market conditions and a lack of liquidity dampen enthusiasm for emerging managers.

More than a third of investors (34 percent) are less likely to invest in first-time managers in the next 12 months, according to Private Debt Investor’s LP Perspectives 2023 Study. This is up from 14 percent in last year’s survey and 22 percent in the 2021 study, which captured investor sentiment following the first year of the covid pandemic.

Rishi Chhabria, partner and head of sales in North America at Campbell Lutyens, says LP concerns towards investing in emerging managers include a severe liquidity squeeze caused by a slowdown in M&A activity, as well as the increasing speed with which larger managers are growing and coming back to market – and with ever-bigger funds. This, Chhabria says, “further squeezes institutions as their capital is going to a more concentrated book of managers and limiting their ability to back new groups”.

On a more positive note, 58 percent of LPs are planning to increase the overall number of GP relationships over the next 12 months, which could open doors for emerging managers.

Feeling the squeeze

With larger GPs continuing to attract the lion’s share of LP commitments, there are fewer opportunities for emerging managers trying to lure away LPs’ already limited capital. This is being exacerbated by prolonged fundraising processes.

Chhabria says: “Many managers have had protracted fundraises that will not be completed in 2022. One of our institutional investors, for example, told me that 75 percent of their entire private equity book was back in market in 2022. That trend is going to push into 2023, and that’s going to further squeeze investors’ general ability to back managers [in general] next year, not just first-time funds, as [LPs] continue to face this effective glut of re-ups that they have to focus on.

“If you’re considering all of these points, I’m not surprised to see folks are becoming less likely to invest in first-time funds. It’s not because of a lack of interest, but instead because of a lack of liquidity.”

According to a survey of LPs and emerging managers conducted by affiliate title Buyouts in partnership with Gen II Fund Services and published in October, nearly two-thirds of GP respondents either agree or strongly agree that investors are hesitant about backing emerging managers; only 15 percent disagree.

“Appetite for emerging managers is often procyclical,” Scott Reed, co-head of US private equity at abrdn, told Buyouts. “When the economy is stable and distributions are strong, LPs are more willing to step out on the risk spectrum and commit capital to newer firms. But history shows us that when markets become more volatile and distributions dry up, a lot of LPs focus their capital on tried-and-true managers, and appetite for emerging managers wanes. That is what we are seeing today.”

In such a market, new managers will need to ensure their offering is differentiated enough to stand out from both their peers and more established GPs.

“LPs are often so tied up with re-ups that they don’t have the bandwidth to review new relationships,” Paul Newsome, private equity partner and head of portfolio management at Unigestion, told Buyouts. “The biggest challenge that emerging managers face is cutting through that noise to get in front of potential investors.”

However, that’s not to say the picture is completely bleak for emerging managers going into 2023. A slightly higher proportion of respondents to the LP Perspectives 2023 Study say they are more likely to invest with first-time managers this year compared with last year, up from 5 percent to 7 percent, while a further 27 percent say they are just as likely do so.