What do LPs want?

Performance and team stability are probably the two biggest factors LPs look at when choosing a private fund manager. But that almost goes without saying; it's a bit like saying the perfect date is someone who’s beautiful and smart. What does it actually mean in practice when it comes to choosing the right partner?

Let’s start with performance. One of the big themes at this year’s PEI Investor Relations Forum 2014, which took place last week in New York City, is that every GP seems to have found a way to market itself as top-quartile, rendering the term practically meaningless. In fact, catchphrases like ‘top quartile’, ‘proprietary dealflow' and ‘proven operating model’ are popping up in GPs’ marketing pitches so often that LPs say they’re now struggling to distinguish fund advisors from one another. Add in the fact that the industry has no comprehensive database, nor a commonly accepted method of assessing performance, and it’s easy to see how GPs can (at least to some degree) get away with manipulating their track record data.

However, investors are wising up to sharp practices. At the conference, LPs said that they’re increasingly looking for better ways to measure GP performance. Many cited the public market equivalent (PME) metric – which looks to provide a comparison with what happened in the public equity market between the times of drawdowns and distributions – as the best way forward. Indeed, traditional metrics like IRR and money multiples are being increasingly questioned by industry academics.

Complicating the matter further still is the issue of persistence. Even if a reliable beauty standard can be agreed upon, it seems that looks can fade: only about one in four top-quartile managers can repeat that achievement in a successor fund, according to fresh research from the Oxford University Saïd Business School.

Of course this is part of the reason why team stability is given so much importance. LPs want the same partners responsible for previous success to continue that run into the firm’s next fund. But here, too, LPs say things feel a bit like dating: they’re never really sure what they’re going to get because GPs put their best foot forward during the courtship phase. At the conference, LPs said that they’d like more conversations with operating partners responsible for value-add, or more junior-level team members, to see that senior management’s investment philosophy and discipline is being instilled throughout the firm.

In the end, there’s always going to be some element of rolling the dice when choosing a GP, something LPs openly acknowledged during on-stage conference panels. But to limit the risk, investors say they want to be wooed longer.

“It’s insulting to think that after a great meeting or some rock star annual conference that I’d be ready to commit,” was how one LP in attendance put it to us. “This wasn’t the case in the past, but winning a commitment today is a marathon, not a sprint.”

Translation: it’s going to take more meetings and more feel-good efforts for certain LPs to get comfortable about partnering with you. These days, that process can take months (or years). But isn't that true of all good relationships?