ILPA's 2023 Members' Conference Takeaways

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I recently attended ILPA’s 2023 Members’ Conference. It’s an LP only event that has a number of great presentations and discussions on private markets. It’s always helpful to see how other LP’s are dealing with the numerous issues we face as private markets investors. It’s nice to have a conference where the content is built around practical issues and solutions, not managers promoting their strategies.

Below are my notes from various panels and discussions.

On Fund/Asset Valuation

  • LP’s are very skeptical on fund/portfolio company valuation. There was (and always has been) justification from the GP/accounting teams emphasizing the substantial rules, process, work, etc, of the audit process. But in my experience, there is 1) incredible variability and flexibility in valuation assumptions, and 2) GP’s know the companies much better than accountants and will craft a compelling narrative on why adjustments should shift in the desired direction. Are accountants really going to tell a GP they know the assumptions/value better than the GP? I doubt it. In my experience, auditors want to document their process and limit their liability, not push back against the GP.

  • Of course, GP’s will never deliberately ask for a specific valuation to maintain certain IRRs so fundraising is easier. But GP’s are great at telling stories about why the relevant comparable set needs to be “updated” to reflect what a great asset the investment is…

  • A majority of GP’s are using EBITDA adjustments; some are legit and some are not; the challenge is getting clarity on the adjustments so LP’s can have clarity on a portfolio company’s health.

  • I rarely see the adjustments, even when I’m on the LPAC. It’s just one more thing that has to be asked about in order to get the right information.

  • Valuation is a tough exercise, especially when it comes to private assets. No one is expecting perfection, just consistency. LP’s want a consistent and observable process to understand the stated valuation and/or any changes. Don’t just give us the number.

  • One idea was to set valuation variables at acquisition. LP’s don’t have an issue with valuations changing. It’s not knowing how the methodology and/or inputs are changing that bother the LPs.

  • There was a suggestion that GPs currently in market with their latest fund had higher MOICs on the existing funds and funds closer to hitting the pref also had higher MOICs. The point being that GP’s are exaggerating valuations to hit the pref or drive performance. It’s hard to get definitive data and a conclusive answer, but since incentives drive behavior, you could see some GP’s abuse that discretion.

  • Which is why current returns, based on unrealized valuations, play almost no role in my evaluation of a manager. Most of those valuations are market and sentiment driven and it’s hard to attribute to the manager. When you’re inside of year 5 on any given fund it’s too early to draw conclusions since valuations lack substance.

  • Volatility laundering was discussed. If you haven’t heard the term, it’s an idea (popularized by Clifford Asness of AQR) that the economic volatility and actual risk of private assets are understated because everyone focuses on accounting volatility, not economic volatility. Because these assets are private, of course accounting volatility is lower. And many GP’s use that as an argument for the superiority of private assets.

  • Most GP presentations highlight their strategy’s incredible Sharpe ratio or lack of volatility of their private assets. It’s entirely misleading. So don’t confuse a lack of price movement because of quarterly measurement with the actual economic risk of the assets themselves.

    On Fundraising

  • No surprise that fundraising is tougher. Funds that are raising bigger subsequent funds, even those with good performance, are facing the biggest pushback.

  • The biggest takeaway – given the shifting balance of power away from the GP and toward the LP, now is the time to ask for terms/language you previously couldn’t get. I anecdotally heard more LP’s actually using the greatest leverage tool they have: walking away. In the past, LP’s would incessantly complain but still re-up. Now, LP’s are sitting out, which is ultimately what must be done to drive change. Some of this is due to the denominator effect, but some LP’s are finally standing their ground. No amount of complaining/lobbying/begging will work without the power to walk away.

  • First time funds are almost all experienced private equity teams spun out of previous PE firms. The industry used to see consultants and investment bankers trying to raise funds, but not anymore. As I’ve always believed, investing and managing capital is much different than buying and selling assets with no skin in the game. It’s a different skillset.

  • The secondary market is appx 50% LP led and 50% GP led.

  • Remember, some states require the use of ILPA’s templates for their pension plans, so if your GP claims they can’t provide a certain template, they often just don’t want to do the work.

  • Start by examining legal issues up front so you are able to walk away and become less committed towards the end of the process.

  • Make sure the end-of-life fees are at or close to zero; or at least require negotiation on fees at the end of the fund term.

    On Fund Finance

  • I was fortunate to be on a panel discussing fund finance – sub lines, NAV lines, CFOs (Collateralized Fund Obligations), secondaries, etc. There’s a lot of interesting work going on at fund lenders and ratings agencies to make these lending facilities work. Most LP’s aren’t aware of the process that goes on behind the scenes.

  • There’s still a lot of angst on the disclosure surrounding the use of sub lines and it’s effect on IRR’s to drive marketing and allow funds to hit their preferred return. Ultimately, sub lines hurt the MOIC and actual dollar return, which is what matters in the end.

  • One interesting takeaway from a panelist was to create two parallel funds: one fund that limits the use of sub lines and the other that maximizes the use of sub lines. Sub lines are an issue even LP’s don’t agree on. Some love it and some hate it. So why not create two different funds that cater to the wishes of the LPs? It’s no different than private credit funds offering unlevered and levered asset funds. Not a hard choice for LPs. So create the same thing but for sub lines.

  • While almost all funds use sub lines, the size of the NAV lending market is probably around 10-15% of the sub line market. I predict NAV lines are going to be almost as common as sub lines given my expectation that the next 5-10 years will be much tougher for private markets and there will be a bigger need for GP and LP liquidity. NAV loans provide this at a much lower cost than preferred equity or an outright secondary sale.

  • LPs should see what’s in their LPA on NAV-based lending just to see who can access these facilities and what approvals are needed. NAV loans will be less controversial than sub lines given the cost is explicit and the benefit is much more direct, whether to generate LP liquidity or facilitate add-ons.

    On SEC Regulations

  • My biggest takeaway on the SEC presentation was the immense lobbying power the GP’s bring to any issue that threatens their business model. This is an area where GP’s have more assets, power, and ultimately, resources to influence the rule making process.

  • If you think GP’s are on your side, you should read the comment letters they submit to derail any change that benefits LP’s. You’ll think twice about how “aligned” you are with your GP’s and if they really care about a true partnership. It makes me question the entire idea of investing in private markets.

    On Diversity

  • Seeing more diversity at back office/accounting functions, but less so on the investment side.

  • It’s important to note that many managers will talk about DEI hiring. But always ask how many DEI hires are staying and not quitting.

  • One big barrier to DEI is getting good data on the underlying employee population. Employees don’t want to offer up data and employers don’t want to violate confidentiality or make it uncomfortable for employees. So we need to think about how to get companies and employers to self-report data so good measurement is possible.

    On Continuation Funds

    • Certainly a hot topic for most LP’s.

    • Used to be a tool for restructuring a fund; now it’s a portfolio management tool.

    • There are generally two classes of GP’s who are doing continuation funds; those who have effectively blown up, have no chance of raising a new fund, and just want to extend the fee revenue; or those who have ongoing franchise value and really believe the asset would benefit from a new fund.

    • LP’s want language/parameters set up during fund formation that govern the continuation fund process.

    • Extra attention should be paid to continuation funds done in the 1st 5 years or with uncalled capital available.

    • Always an option to do a tender offer instead of a continuation fund if only a small number of LP’s want liquidity; GP’s should be doing these if they know the price and volume they can get.

    • Tender offers are often better for LP’s because if you don’t elect anything you stay in the same place; with a continuation fund you are cashed out.

    • Make sure a fund staple doesn’t have a dilutive effect on LP’s; a stapled commitment benefits the GP, not the LP.

    • LPAC’s have incredible power/leverage over this process that I think most LP’s are unaware of. LPAC’s need to approve the waiving of conflicts of interest to allow the continuation fund to proceed. So the LPAC should be demanding the right transparency on valuation and terms that is often missing.

    • LP’s: Do not preclear conflicts of interest.

    • GP’s should be about maximizing value, not hitting a minimum return. Don’t allow GPs to justify a continuation fund by stating some minimum value will be hit; LP’s want maximum value.

    • Ask the GP: is the value creation process enhanced with the use of a continuation vehicle? What does the continuation fund do that the main fund can’t?

    • LP’s should push back on continuation funds with premium carry.

    On the academic side

    • Odds of a top quartile fund raising another top quartile fund is about 25% - no better than chance. It’s becoming harder to pick winning GP’s (and it’s never been easy).

    • Private markets are great, but 2 and 20 isn’t. How to solve? Co-invest! But co-investments have done worse overall. The problem is adverse selection; Co-invest deals are done at the top of the market and are often bigger, which have an outsized negative effect.

    o All investors, including both GPs and LPs, are overaggressive near the top; it’s hard to walk away when the market has gone up and everything seems to be going great.

    • Great funds offer great co-invest; poor funds offer poor co-invest. So be careful which GPs you are sourcing co-invest deals from.

    • It’s not that big funds do worse, but bigger deals do worse.