How is the pension system dealing with the pressures on LPs?
For TRS, there are a handful of things we can do. The first is an overall slowdown in commitment pacing; we don’t know exactly where we’re going to shake out for 2023, that’s a process we’re undergoing right now, but our initial guestimate would indicate it’s going to be a medium-sized decrease year-on-year.
However, at TRS we strongly believe in the importance of vintage year diversification, so any reduction in commitment pacing will be balanced with the goal to continue to be a reliable partner and active co-investor when valuations may be more attractive.
That’s one tool. The second main tool is we’re really focusing a lot more on our commitments. So we’re digging deeper on our underwritings, and we’re making sure we’re backing the right managers. There are obviously managers we’re not going to back as a result. They may have met the bar last time but in a more constrained capital base, they’re not going to meet the bar this time.
We’re trying to focus our dollars on where we can get the most bang for our buck: who can we be meaningful to? Advisory boards, LPA negotiations and co-investments are all very important to us, and fewer dollars may go further with different managers than they have in the past.
Also, as we focus on our commitments, we’re leaning into partnerships. Now is the time for all sides to show grace to each other. We’ve been with some partners for 10, 15-plus years. We’re being upfront, telling them our commitment size this time may be different than our commitment size last time, but we still think of you as long-term, core, important partners and we would encourage you to think of us as the same. We’re a little bit capital constrained and are demonstrating grace – show us grace as a result.
How are you thinking about secondaries?
We’re very price sensitive as sellers and since we’re not a forced seller, we’re not interested in selling at current market clearing prices. So we’re not active in that regard right now.
What do you look for in managers in the dislocated markets?
There are at least five areas of due diligence where we are spending more time than perhaps we would have been 24 months ago.
The first is analysing fundamental operating performance of the portfolio companies. We’re digging in more on valuation methodologies, relative valuations among managers, and how the portfolio is performing from an operating perspective (eg, revenue, EBITDA, multiples, debt levels).
In an up market, you can spend a whole lot of time digging into the portfolio but it’s really hard to glean too much because everything looks good and everything is growing. But it’s more important in a down market because there are absolutely companies that on paper look like they’re doing well in terms of the valuation that they’re held at, but when you dig in, the valuation could be unjustified or unwarranted. So, we’re kicking the tyres a lot on the fundamental operating performance of portfolio companies.
The second one is strategy drift. We’re really looking at, what was it the GP did over the last five or 10 years that caused them to be successful? And do we think that is replicable going forward?
Third is what we call capacity analysis. This is effectively looking at the number of companies per professional and thinking about whether they are going to have enough time and attention to dedicate not only to new deals but to their existing deals, which we think are going to, all else equal, have more bumps in the road and require more of their time and attention than historically.
Fourth, we’re spending a lot of time on team dynamics and culture. It’s easy for everyone to be happy and a firm to keep its team when everyone’s generating carry and a lot of compensation is being paid to the team. But as soon as there’s some bumps in the road, and perhaps carry doesn’t get paid, or deals start going sideways, are there any cracks in the culture that can cause resentment or dissent among the team which ultimately leads to departures, etc?
Fifth, we’re spending more time on the LPA. There are some terms that skewed a little bit out of whack toward the GPs’ favour in terms of fairness and we’re looking to bring those back to the centre.
How might a first-time fund get into the emerging manager portfolio?
One of the most important things we’re looking for is a verifiable track record that you can point to. That is hard and that’s why first-time funds are so difficult. But there’s a lot of diligence that we do on prior track records – third-party reference calls, piecemealing prior attributable/non-attributable track records together, etc. A lot of time and attention goes into track-record verification in a strategy representative of what you plan to do going forward.
Another important aspect we look for is a manager that is setting up their organisation for long-term success. What does the current team look like, what is the team going to look like five, 10 years from now? We want to be long-term partners, help us ensure that you want to be in business for a long time and you’ve created the infrastructure as such.
In addition, we’re looking for an institutionalised LP base. The last thing we want to do is have huge conviction in a fund and get in the LP line-up and look around and we’re the only one committing to it. While we are comfortable being early in a manager, we still look for an institutionalised LP base that is diversified beyond us as an anchor LP, because we believe that sets them up for success.
And an institutionalised LPA. We want to see an LPA in line with the market that we can be comfortable with. At least in line with the market if not more LP-friendly.