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All eyes on track record during due diligence

Managers’ performance history is still top of mind for investors, and key-person clauses have overtaken fees as the most contentious issue.

A manager’s performance track record, team size and investment capacity, as well as terms and fees, all continue to be at the top of investors’ agenda when it comes to due diligence, according to PERE’s Investor Perspectives 2021 Study. By contrast, and despite their growing importance, ESG and diversity considerations are not yet a key focus for diligence.

For more insights from the Investor Perspectives 2021 Study, click here. For more on how we compiled the study, click here.

“This does surprise me a little, and I suspect this could depend on the location of the investor. We’ve found that European investors are very focused on ESG and diversity, and they do tend to prioritize these elements as part of any due diligence process,” says Anna Morrison, senior director, private markets at investment consultancy bfinance.

Where there is unanimity when it comes to due diligence is on the importance of track record, with 97 percent of surveyed investors saying this tops their diligence concerns. In their search for security, investors have traditionally had a preference to move more of their capital toward the most established managers with longer track records and ample investment capacity, which has been heightened by the pandemic.

“We’re going through difficult times, but most institutional investors still need to deploy their capital and they’re putting that money with people they already know, which is accentuating a flight to quality we have seen over the last few years,” says Matt Posthuma, real estate funds partner at the global law firm Ropes & Gray. “Consequently, more and more of the capital has been raised by a smaller number of managers, which are larger players.”

Meanwhile, the two most time-consuming activities for the majority of respondents are carrying out due diligence on funds and monitoring investment portfolios, cited by
74 percent and 56 percent of investors, respectively.

Contentious terms

When asked which terms of the limited partnership agreement caused the most disagreement with managers during due diligence, an unsatisfactory or absent key-person clause ranks highest, followed by management fees and the structure of carry distribution waterfall. This is a change from last year, where fees were the biggest issue.

Edward Tran, partner at Katten Muchin Rosenman, a multinational law firm, says disruption caused by the pandemic has led to a major sense of uncertainty and fear and, in some cases, decreases in asset values. “This has pushed investors to focus on means of mitigating those challenges, and one of the ways to do this is ensuring that they’re investing in funds they are comfortable with. But it’s also the question of the key person – whether those key individuals are still going to be there and will remain at the helm to steer the fund through these tricky times.”

Discrepancies about fees and carry distribution waterfall remain high, but more options and transparency are seen in today’s market. “We’ve seen some managers offering investors a choice of structures that allow them some optionality between the level of management fees and performance fees,” says Morrison.

Steven Cowins, partner at global law firm Greenberg Traurig, notes that fees are now clearer – albeit rigid, too. “There’s a headline rate and then various discounts. Fees used to be more of a negotiation, whereas now everyone is more transparent.”