PE Tech Report


Like this article?

Sign up to our free newsletter

LPs keep one eye on tech, as impact funds swell

By Colin Leopold – Rising public market valuations and tech-based disruption has pushed investors towards sector specialist managers. Demand is now building for more general macro strategies too…

By Colin Leopold – Rising public market valuations and tech-based disruption has pushed investors towards sector specialist managers. Demand is now building for more general macro strategies too…

Technology was the dominant theme for private equity investors in 2021 – not just in terms of ‘how’ they allocated their capital, but also ‘where’. 

Software companies and fund strategies based on digitalisation were more sought-after than ever, and the trend is still sweeping across other sectors including healthcare and financial services, most notably in payments and insurance solutions. 

According to figures from EY, 30% of total capital deployed in 2021 was allocated to technology companies, followed by firms in the consumer space, with 24 per cent of aggregate deals by value. 

Recent high-profile transactions include Bain Capital and Hellman & Friedman’s USD17bn agreement to buy ‘healthtech’ company Athenahealth, Advent and Permira’s USD12bn move on McAfee Corp and Clearlake Capital’s USD5.4bn agreement to buy Quest Software. 

“Everyone is absolutely blinkered by anything tech at the moment,” says one US-based GP. 

A boom in venture capital (VC) has skewed the market further, drawing more investors into early-stage tech companies and disruption strategies. 

“VC went into hyperdrive in the pandemic,” says Brad Young, global co-CIO, private markets, at Mercer. “It’s being driven by things like healthcare and working from home, so I think the growth will continue for the foreseeable future.” 

New venture fund allocations to healthcare increased by 30% on 2020’s record with investment into companies exceeding USD86bn in the US and EU, according to Silicon Valley Bank’s annual healthcare investments and exits report. Healthtech experienced the greatest increase in investment of 162%, driven in part by the medical devices market, which saw a four-times increase in European investment specifically. 

Demand from LPs for tech-based strategies will continue during 2022, say fund managers, but it will be tested by even larger tech buyout funds, such as Vista Equity Partners, Thoma Bravo, Silver Lake and Francisco Partners, coming back to the fundraising market. 

Valuations in the technology sector are also raising some eyebrows among LPs: EBITDA multiples now regularly hit or exceed 20x after a decade of rising investment. 

Technology-linked assets have generally attracted increasingly higher valuations over the past decade, taking cues from rises in the public markets and the promises of cloud-based software and blockchain. But in January this year, tech stocks dramatically shed USD2.5trn in value since their November 2021 record high, as fears of rising interest rates hit the market. 

Tech play

“I think you have LPs that are worried about the amount of exposure that they have in the tech space and then you have LPs are saying ‘This is the thing that’s gonna play out over the next 30, 40, 50 years,” says Peter Witte at EY. 

The prevailing view is that we are still in the early stages of the tech boom, he adds. “It still has a lot of runway to go.” 

After extending into healthcare, specialised tech-based strategies will continue to steer the boom in VC while also more strongly influencing investment in sectors such as food and agriculture and the energy transition, says Gabrielle Joseph, head of due diligence and client development at placement agent Rede Partners. 

Opportunities around technology-based farming, food processing and supply chains and logistics are all being pitched to investors by specialist funds. 

“Investors’ approach to [technology] assets has become more sophisticated,” says Jérôme Chevalier, founding partner of tech and healthcare-based Quadrille Capital. “GPs are pivoting away from pursuing disrupters in favour of companies with clear and financed pathways to further growth.” 

According to Commonfund Capital’s fourth annual private markets investor sentiment survey last year, 40 per cent of investors said they will direct more money toward sector-specialist buyout funds, and 33 per cent for generalist funds. Investors also favoured venture capital for returns and allocations, with 38 per cent planning to boost allocations and more than half expecting above average or high return potential. 

First-time and emerging managers have traditionally attempted to differentiate themselves from larger brand names GPs with a more specialised or sector-based strategy. Research shows that investments by sector-specialist private equity funds tend to outperform those by generalists by a small margin, but an overspecialisation can also alienate new LPs and limit investment opportunities. 

One fund strategy which has instead opened doors in 2021 has been impact investment, with larger managers including TPG, KKR and Bain using USD 1bn-plus platforms extensions and spin-offs to garner mainstream attention. 

“The great thing about impact investment is that it is such an equal opportunity investment approach,” wrote Tania Carnegie, Global Lead, Private Equity & Asset Management, KPMG IMPACT last year. “It can be scaled and adapted to all different types of investors, across asset classes, sizes and geographies. What we are seeing now is a far greater breadth of investors getting involved, recognizing that potential.” 

Impact gap

There is still much more room for fundraising in this space. 

In a survey of global LPs by HarbourVest Partners, three in four respondents (72 percent) said they plan to increase their allocation targets to sustainability and impact investing within the next two years. The survey found that LPs remain under-committed versus their targets for sustainable and impact investing strategies, with a nine-point gap between their target allocation (21 percent) and their actual allocation to these strategies (12 percent). 

Impact investment strategies particularly appeal to institutional investors because of their high ESG score but also because they tend to have global and wider cross-sector exposure. 

During 2022, the performance of tech-focused fund strategies – whether IT or sector-based – will be balanced increasingly with the opportunities in impact investors and the potential for ESG value creation in other sectors.

Read the rest of the Future flows: The next generation of private equity LPs Insight Report

Like this article? Sign up to our free newsletter