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Private equity LPs fall short on key competencies, says eFront survey

Private equity LPs lack sophistication in areas such as negotiation, reporting and position monitoring, according to a new study by eFront.

The report, which canvassed the opinions of LPs ranging from high net worth individuals to major pension plans, finds that investors are falling short of industry best practice in several areas. In all, 179 investors from across the globe rated their approach to 10 private equity investment competencies, selecting from answers graded in terms of sophistication.
 
The weakest categories for LPs were: negotiation, where more than a third of LPs (35 per cent) do not attempt to seek better alignment with GPs or separate accounts; reporting, where nearly half (45 per cent) of investors rely entirely on GP-provided material and do not seek standardised/digitised information that supports advanced analytics; and position monitoring, where more than half of investors (53 per cent) use the simplest form of monitoring, failing to leverage integrated systems for analytics and industry-wide transaction libraries.
 
The strongest metrics for LPs were: private equity allocation, where more than 90 per cent of respondents display a high or medium level of proficiency; return metrics, where more than 85 per cent of investors use sophisticated methods to measure performance; and risk management, where 46 per cent take a rounded and comprehensive approach – though at the same time nearly a third (31 per cent) use the very simplest, least comprehensive measures. Given that this is the competency area with largest dispersion in answers, the benchmarks are less clearly defined.
 
Tarek Chouman, CEO of eFront, says: “There is no shortage of commentary about the value created by general partners of private equity funds. Much less consideration is given to the value added by the proficient and engaged limited partner. And yet such is the complexity of managing a portfolio of private equity funds, and such is the range of sophistication in how LPs approach this challenge, that the LP value creation dynamic ought to be a major consideration.”
 
eFront’s analysis showed that, while investors perform very well across a number of key metrics, their sophistication score sits below half marks in six of the ten skill categories studied. LPs performed particularly poorly in negotiation, where more than a third focus on very simple negotiating points. Meanwhile, just a tenth seek a segregated account or the option to make the final decision on capital deployment.
 
In reporting and information exchange, there is significant variation in sophistication. The largest proportion of LPs (45 per cent) passively accept GP information and do no detailed analysis of NAV or distributions, while only 17 per cent of the respondents in the survey reported that they employ the use of platforms that collect and streamline this type of report.
 
LPs received their lowest score in position monitoring, where more than half of investors (53 per cent) use the simplest form of monitoring and just 15 per cent exploit integrated systems that pair proprietary data with third-party sources, enabling sophisticated analysis.
 
On the positive side, LPs appear to be highly proficient at determining the appropriate private market allocation. This competency has the least divergence among the investors, and the fewest low scores, with just 8 per cent of investors passively following their peer group to determine allocations. Indeed, no pension fund or fund of funds respondents followed this least sophisticated strategy.
 
Performance measurement, meanwhile, is the area of greatest proficiency among LPs, with more than 85 per cent of investors using sophisticated methods and just 14 per cent of respondents using a simple IRR calculation to measure performance.
 
Risk measurement was the third-strongest category, but the way LPs measure risk varies greatly. This may indicate that there are no clearly established benchmarks in this competency area and that self-assessment choice depends on the internally defined benchmarks within each organization. Almost a third of respondents devise a simple metric which is equivalent to public market volatility; almost a quarter use Value-at-Risk methodology and track correlations between values of different positions in portfolio; and 46 per cent take a comprehensive and rounded approach, encompassing specific metrics and extraneous risks.
 
Chouman says: “You might think that respondents would be tempted to inflate their own sophistication, and it is possible that there is some confidence bias in the results. But the overall picture is endlessly revealing. The highest area of proficiency is in return measurement, while areas of relatively poor proficiency, such as liquidity targets, negotiating priorities, position management, benchmarking and information exchange leave the most room for improvement in performance. Equally fascinating is how different investor types vary in sophistication. While there is inevitably an advantage for larger players, this is by no means the case across all competencies.”

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