Survey says

Private Equity Real Estate recently conducted its first survey of general partners' opinions on the limited partner community—the results were illuminating. By Dave Keating

The relationship between GPs and LPs can be a complicated one. Although they are joined together in a common interest, the two parties can often have very different expectations and goals. Perhaps that's why so many GPs cite fundraising as one of their least favorite parts of the job. Flying around the world to raise capital may be the cost of doing business, but that doesn't mean it's not a grueling process.

Of course, having investors who are like-minded can help alleviate the more unpleasant aspects of the endeavor. For this reason, it makes sense that there are specific qualities GPs like to see in the people they do business with. Surprisingly, however, there has been little study into exactly what those qualities might be.

It was with this in mind that PERE conducted its first survey of GPs on their attitudes towards the limited partner community. The survey was sent to private equity real estate general partners only, with no placement agents, consultants or other types of industry professionals participating. Given that no GP wants to publicly dish about their relationship with an investor, participants were told that their responses would be kept anonymous and confidential. We also spoke with independent analysts to get their anonymous take on the results and to find out what they hear most often from GPs about their limited partners. The survey was sent to more than 100 industry professionals and the results were, if not surprising, certainly illuminating.

“It's all about speed. Foundations and endowments work more quickly than their public fund counterparts.”

The most obvious thing a GP is looking for in an LP is cash. And what an LP expects from a GP is high returns. It is in essence a pretty straightforward relationship.

Yet the relationship is a bit more complicated than such a simple analysis suggests—it also leaves out the human angle. LPs know that the best predictors for those high returns are identifying a GP with a clear investment strategy, a capable infrastructure, a solid record of performance and an economic alignment of interests. GPs, on the other hand, not only want an investor who will understand their investment proposition, but also one who is smart and well-informed. PERE's study suggests that GPs want their LPs to be honest and transparent, to have an indepth knowledge of the asset class and, most importantly, to commit to funds quickly.

Looking at the results of the survey, GP respondents say a speedy commitment is the most valued trait they look for an LP. “Opportunities never wait,” noted one GP. “Smart LPs move quickly and with the greatest conviction,” added another.

One analyst we spoke with said he isn't surprised by the need for speed. “That outcome is because of the current marketplace,” he said. “LPs are crushed today with needing to get quick responses to GPs. With funds being oversubscribed, GPs value that speed in commitment because they've been able to make those sorts of demands on LPs. And if the LPs don't get back to them in time, there are plenty of other LPs who will.”

Knowledge of the real estate world and long-term outlook were also repeatedly mentioned by respondents as a valuable trait in an LP. One survey participant noted, “Long-term outlook provides the investors with optimized returns and safety.” Others said that their favorite investors were those that had a long-term strategy of investing with the firm. One GP noted that his favorite LPs are those that “come into successive funds (even if one of the previous funds did not meet its return threshold) and also suggest other potential investors.”

“The personal connection is what's most important,” said one analyst who thinks long-term relationships are what GPs look for the most. “Essentially they want long-term partnerships, they want to bring in partners that are like-minded and who they get along with on a personal level.”

The analyst said that fundamental need may likely explain the results of the survey's next section, which asked GPs which type of investors they prefer. The results showed that foundations and endowments ranked the highest; banks and insurance companies were their least favorite.

“Again, it's all about speed,” he said. “Foundations and endowments work more quickly than their public fund counterparts.”

The results and comments seem to suggest that the most important aspect of an LP is not the type of institution but rather the individuals involved at that institution. GPs and analysts alike said that foundations and endowments are better at minimizing staff turnover, which allows for a more consistent dialogue and outlook. In other words, GPs like to see their LP representatives stick around for a long time.

“GPs get ticked off when they see high turnover,” said one industry professional. “Somebody goes through the entire underwriting process, makes a commitment, and then a year later they're gone. And the next time the GP comes back, when it's time to commit to the next fund, they have to educate the new person, tell them what's in their portfolio. You tend to find that more in the state pension plan world and not often in the endowment world.”

Going along with the theme of personal relationships, one frequently cited component of any successful GP/LP relationship was communication. The industry professionals said that it is essential for GPs to know the internal processes of their investors, and that those processes must be communicated effectively.

“The biggest mistake I see LPs make is not letting their GPs know what's going on behind the scenes,” said one analyst. “If something is under a short time fuse, which they increasingly are in this market, it becomes more and more of an issue if they can't get in the funds they want to get into, or not at the amount they want.”

The survey also asked the respondents to rank the investors they rate most highly. A few names came up frequently in the results. CalSTRS and CalPERS were the respondent's favorite state pension plans, while the MacArthur Foundation and Duke University emerged as the favorite foundations or endowments. Verizon was on top in a ranking of the respondent's favorite corporate pension plans. Duke University, Yale University, and CalPERS were the most frequently mentioned LPs in the results as a whole.

While the results are interesting, one analyst we spoke with observed that different firms will always have different kinds of preferences.

“A large firm doesn't give a doodle about who the LPs are, as long as they give them money. That's a very different answer than you'll get from a smaller, first time buyout fund.”

“If you're a start-up fund then you'll love the Yales and the Harvards, but if you're a bigger player they may not be as attractive because they're more aggressive with diligence,” he said. “The answer from a spin-off group is going to be radically different from a large firm. A large firm doesn't give a doodle about who the LPs are, as long as they give them money. That's a very different answer than you'll get from a smaller, first time buyout fund.”

However, another analyst disagreed, saying that no matter how big the GP's firm is, they're all looking for one thing in their LPs: honesty.

“What I hear from GPs is, they want somebody who calls it like he sees it, someone who is open and honest and communicative,” he said.

“They really appreciate candor and straightforwardness,” said another industry professional. “A lot of LPs aren't as good at delivering bad news, like why they're passing on a fund. But those that are honest and upfront are respected by GPs, even though they may not like the answer.”

Judging from the comments received in the study and the ensuing analysis, the two primary features GPs are looking for in their investors are speed and transparency. As one survey participant put it: “We want investors that understand and are realistic in their outlook. Of course, speed of commitment is always highly valued.” It's hard to say whether GPs are willing to sacrifice this speed in order to get more knowledgeable or honest LPs. However at least one analyst thinks GPs should be looking more at the quality of their investors than at their speed of commitment.

“We're seeing a market where I think LPs are forced into making decisions faster than they would prefer to make,” he said. “It's difficult to apply a lot of these lessons when you're given a constrained amount of time to do your work. Most people have a tendency to double or triple down assuming that the velocity of realizations is going to continue. It's hard to put your head above the parapet and get a more panoramic view of the market. When that happens, portfolios get overweighted with whatever the hot asset class is.”

For a relationship at the heart of the asset class, the LP/GP interaction can certainly get complicated. But as our respondents pointed out, with the right qualities an LP can make the process much more pleasant for everyone involved.