Active vs. Passive LP involvement: Finding the right approach
When it comes to private equity funds, the investors, more commonly known as the Limited Partners (LPs), have traditionally taken a hands-off approach, entrusting day-to-day management and decision-making to the PE fund’s General Partner (GP). But this is now changing. As funds become increasingly complex, and with many funds underperforming against a challenging macro backdrop, many LPs are starting to see the benefits of taking a more active approach. This is especially so where LPs may fear that the GP’s interests are not fully aligned with their own. And time is often of the essence – the longer LPs wait, the greater the risk of value destruction. Striking the right balance between active and passive strategies can help to protect LPs’ capital and ensure the GP’s interests are aligned with theirs. But deciding when to act, and coordinating efforts, can be a challenge. At Cork Gully Asset Managers (CGAM), we provide a fully independent and expert third party advisory service to LPs. Here, we explore the issues at stake, and offer some practical guidance.
Passive LPs typically reserve their activity to providing capital, reviewing periodic fund reports and attending annual meetings. This approach is fine as long as the GP has a proven track record, the fund performance is in line with expectations, and market conditions and outlook are relatively stable.
Active LPs, on the other hand, will assume greater oversight and seek to have influence in fund management and decision-making. For example, they may form Limited Partner Advisory Committees (LPACs) to increase their bargaining power to influence key decisions related to fund extensions, valuations or conflicts of interest. LPs may also engage independent advisors. These advisors can be extremely useful, as they will provide unbiased fund performance reviews and also, where necessary, guide LPs who wish to drive effective and efficient wind downs and liquidations as a route to value recovery. In this context, independent advisors can bring private equity capabilities to help accelerate the process of value realisation. They will also guide LPs who wish to push for change, such as a replacement of the GP, or a restructuring.
Active involvement therefore needs experience, deep engagement and expertise, all of which require substantial resource. This is where appointing an external advisor can be invaluable, as there is no doubt that an active approach can yield better outcomes in complex scenarios.
We believe that LPs should consider switching to an active approach when faced with the following scenarios:
- a fund is consistently underperforming;
- there appears to be a misalignment of interests such as excessive fees or conflicts of interest;
- a fund is nearing its end of life and presenting challenges, such as illiquid assets or unresolved governance issues;
- a fund is operating in a high-risk geography or volatile sectors and requires closer LP oversight to ensure risk mitigation and compliance
At CGAM we have advised and guided many LPs in adopting active engagement strategies to optimise value. These have included exercising influence in the LPAC to manage conflicts; offering objective insights into fund performance; and facilitating LP communications with GPs to reduce conflict and secure the best possible outcome for LPs’ interests.
Our experience tells us that active involvement can deliver significant value and it also demands resource and expertise. To strike the right balance, LPs should consider their internal capacity in terms of expertise and weigh the potential returns from intervening against the related risks and costs. An external advisor can help with this. Adopting a thoughtful, strategic approach to active engagement can help to ensure that LPs safeguard their interests, improve governance and drive better outcomes.
