by Cameron Nicol, Senior Marketing Manager – eVestment Private Markets
It’s a trend you’ll likely have experienced first-hand as a member of a private fund manager’s Investor Relations or Finance team – increasingly complex, granular and frequent requests for your fund and deal performance data from LPs. In fact, nearly 4/5 fund managers have experienced increasingly granular performance data requests from investors when compared to their previous fundraises (eVestment Private Markets, 2018).
Investors are doing more with this data, too: 75% of LPs always or often recalculate track records, citing the need to verify performance and understand how a manager has created value as reasons behind these requests and practices (eVestment Private Markets, 2018).
But how are LPs really evaluating your track record? What metrics do they view as most important? And why should you care as a GP?
Why GPs Should Care How an LP Analyzes their Track Record
With GPs in market targeting more than $320 billion of capital for buyout fund strategies alone as of July, 2019 (Private Equity International), the fundraising landscape is bustling, but also crowded. The challenge of winning LP commitments is further exacerbated by the finding that only 25% of LPs are looking to expand manager relationships (eVestment Private Markets, 2019).
In this environment, the need to differentiate yourself from other funds and gain the trust of investors has never been more impactful to the success of a raise. Increasingly so, this is done through transparent and data-driven communications that can only be achieved through thorough analysis and interrogation of your own track record.
Looking at Your Funds like an LP
With LPs digging deeper than ever into past performance, you must be able to match this level of analysis of your track record.
Looking at your funds like an LP can help you identify their strengths and weaknesses before fundraising, and formulate confident, clear and consistent answers to investors’ questions.
While overall performance, team, terms, and other factors certainly still matters to LPs when making decisions, showing you know your firm’s strengths, being transparent about poorer performing areas and making compelling, data-driven messaging is a powerful differentiator from similar performing funds.
What Performance Metrics are Most Important to LPs
In a 2019 eVestment Private Markets survey, private markets investors and fund managers were queried about the analysis they place the most importance on during their respective quantitative due diligence and portfolio analysis processes. In general, the findings highlighted that managers underestimate the level of importance of the analysis that investors perform.
Three of the areas where this difference in opinion was most pronounced were Loss Ratios, Public Market Equivalents, and Horizon Returns.
One stark contrast identified in the findings was on the level of importance of Loss Ratios. This was ranked second by investors, yet only fourth most important by fund managers.
Over two-thirds of investors, 68%, indicated Loss Ratios as very important in the due diligence process versus just 32% of fund managers. In fact, a full third of fund managers ascribed no importance to Loss Ratios.
Public Market Equivalent Analysis
Another striking contrast was in relation to Public Market Equivalent (PME) analysis. The survey findings show that this benchmarking practice remains an important tool in investors’ due diligence process, with 43% suggesting it was very important. Yet fund managers do not share the same opinion, as just 15% of fund managers ascribed PME the same level of importance.
Previous eVestment Private Markets Research has shown that investors can be very sophisticated in their use of PME analysis, leveraging different blends of indices and methodologies. A 2018 report highlighted 46% of investors and consultants were using more than one index, and a significant proportion using more than one methodology, in their PME analysis. As such, managers would be well prepared to have the flexibility to quickly and precisely benchmark against a variety of indices to be able to have better informed discussions on their funds’ performance.
A new factor to appear in the 2019 study was the use of Horizon IRRs: calculating performance across one-, three-, five- and 10-year time periods. As private markets allocations have grown in size in many institutional portfolios, reporting and benchmarking performance against other asset classes has become a key requirement, and is represented using these horizon-based return periods.
Perhaps given this trend, a quarter of investors indicated Horizon IRRs were very important as opposed to 42% of fund managers who placed no importance on their use.
Again, while managers may have no need to calculate Horizon-based IRRs for their own reporting, having the ability to display and understand their performance in this way can only help in pitching and conversing with their investors.