The 2019 Private Funds CFO Insight Survey shows just how prevalent strategy diversification has become among private equity managers. Last year, 22 percent of respondents said they planned to launch a new fund with a strategy that was different from their firm’s heritage. This year, 29 percent say the same.
Of all factors, market opportunity remains the most critical consideration in a firm’s decision to diversify strategy (33 percent of respondents).
“In venture this [trend] is a function of greater opportunity sets identified by fund managers,” says John Otterson, partner at Jackson Square Ventures. “We have seen a profound shift in time/stage of when companies go public. That has brought an array of new entrants to the venture follow-on space.”
In real estate, the decision to shift strategy hinges on a manager’s ability to produce yield at the current level of investment risk, says one CFO. “Firms know how to invest in certain types of real estate, but the yields on that real estate have slightly declined. Rather than change your expertise, change your strategy, right!?”
Expanding fund sizes also have a role to play. As managers “start to cap out on how much they can grow their current strategy” they switch strategy to continue growing. “A single successful investment strategy cannot last forever due to mean reversion,” adds Dimitri Korvyakov, CFO at Sandton Capital Partners. “Some investment strategies become too crowded and that drives a decrease in investment returns or the macroeconomic conditions beneficial to the strategy start to deteriorate. Investment firms have to look for new cutting edge strategies within their area of expertise or in a related area.”
As ever, investor demand is an important part of the picture. Forty-two percent of respondents note it was a very important or critical factor in their decision to launch a new fund with a new strategy. “LPs are concentrating their bets and GPs are accommodating the trend by offering more, which benefits both the LP and the GP,” says Bill Tomai, Centre Partners’ CFO.
However, a decision to step out with a new strategy is not without risks. One CFO is cautious. “As an investor, I would be hesitant to give my money to a manager that has no experience in a certain product type.”
The roll out of the Opportunity Zone Program – wrapped into President Trump’s 2017 tax overhaul – has not been smooth.
The scheme is supposed to reward investors with tax incentives to finance the regeneration of almost 9,000 deprived urban areas. But the program’s detractors have criticised the lack of transparency and questioned whether the money is being invested in areas that need it most.
Our respondents echo this uncertainty, with 70 percent unsure whether the program will have its intended impact. More than half say they will not be using it, while 20 percent are still deciding (a further 18 percent say it is not applicable to them). Its untested nature is a key deterrent for 39 percent of respondents, while a similar percentage cite evolving Internal Revenue Service regulations as off-putting. Among other obstacles, one respondent describes the challenge of matching up the timing of deals with the timing of investor interest and closings, as a “chicken and egg problem.”