LP shift to direct investing puts pressure on talent supply

The growing appetite for direct investments among institutional investors is intensifying competition for high-quality talent.

Around three-fifths of limited partners find recruiting enough talent and other internal resource constraints significant barriers to improving private equity returns, according to Coller Capital’s Global Private Equity Barometer. The report surveyed 112 private equity investors in North America, Europe and Asia-Pacific including asset managers, insurance companies and public pensions.

Many LPs have sought to cut back on fees in recent years by deploying more money directly into businesses, rather than committing capital to funds. The California Public Employees’ Retirement System is the latest to enter this strategy, having launched a direct investment programme in May.

Such deals require a skillset more akin to that of a GP than the traditional LP model, meaning investors and managers could be looking to the same talent pool when building teams.

“I see pressure on the direct investment side, where they’re competing against GPs to hire staff to make direct private equity investments from the LP’s own money and disintermediating the private equity fund manager entirely,” Simon Havers, consultant at talent specialist Odgers Berndtson told Private Equity International. “That’s very evident.”

GPs can attract talent – especially to senior positions – with generous shares of carried interest or other incentives, something traditional LPs may find it difficult to compete on. Blackstone chairman and chief executive Stephen Schwarzman, for example, saw his carried interest and incentive fee distributions almost triple to $123.8 million last year.

Such incentives are not limited to GPs. At least 80 percent of corporate pension funds and 77 percent of banks or asset managers have an element of compensation tied to the performance of their institution’s private equity performance, according to the Coller report. By contrast, just 41 percent of public or other pension funds and the same proportion of insurance companies employ such a strategy.

Those who do not incentivize their staff may rue the decision. LPs whose remuneration is tied to private equity performance are almost three times more likely to deliver annual returns in excess of 16 percent than their peers, the report noted.

“What some of those LPs are able to take advantage of is disillusionment of some middle-ranking staff in larger private equity funds, for whom carried interest has taken longer to appear than they imagined it would, and who are therefore perhaps willing to give up that carried interest in return for a more exciting looking annual bonus,” Havers added.

With soaring valuations making it more challenging for GPs to deploy capital, pension funds can be more attractive to investment professionals because they have to put capital to work.

“There’s a fairly good supply of good private equity investment individuals in the market, keen to find firms which have got capital and the willingness to deploy it even though market pricing is, by historic standards, high at the moment,” Havers said. “If you’re trying to build a career in private equity, you really don’t want to be somewhere where the investment committee is unsure about whether it wants to be investing at all.”