The Private Equity Due Diligence Gap

Institutional LPs overwhelmingly trust GPs’ own performance data—unlike their private-sector counterparts.

Any private equity firm with a fluffed track record ought to steer clear of large allocators ($5 billion-plus), funds-of-funds, and all North Americans.

Or just not fudge their numbers. 

Allocators reported vast differences in quantitative due diligence practices to data firm eVestment, which surveyed pensions, endowments, insurers, and private equity funds-of-funds. These limited partners (LPs) managed $3.4 trillion in total assets and $140 billion in private equity, from North America, EMEA, and Asia.

Inconsistency across managers’ return methodologies plagued LPs of every stripe—one of the few points of agreement. Eight out of ten LPs surveyed said it wasn’t “easy to compare one fund manager’s performance numbers with another” fairly and consistently. 

This longstanding lack of standardization “is still viewed as a challenge,” eVestment’s report stated, and threatens “breaking down the trust” between LPs and general partners (GPs). 

How Often LPs Trust Manager-Provided Data Private Equity Performance Data eVestment Source: “Private Equity LP Due Diligence Trends 2016,” eVestment

Trust in GPs has already lapsed for more than half of fund-of-funds respondents (54%), who “rarely or never” trust manager-provided data. 

In striking contrast, nearly all surveyed pensions and endowments (94%) “often” have confidence in GPs’ numbers. But that’s not to say institutions took managers at their word. 

The ‘trust but verify’ maxim reflected in this group’s due diligence practices: Half of pensions and endowments always recalculate track records, the survey found, versus 38% of funds-of-funds. 

Size of private equity portfolios also correlated strongly with return verification. Below $5 billion, roughly one in three LPs took this step, while 88% of investors overseeing $5 billion-plus said they “always” recalculate. 

Asked for advice to GPs for fostering trust (and thus assets under management), LPs shared a common message: Transparency. 

“Just tell us—‘this is what my performance is, this is why,’” said one allocator. “We’re going to find it anyway, and the fact that it takes my time and your time is just a waste of both of our times to get there in the end.”

Related:  Why Due Diligence Is Broken, and How 18 CIOs Would Fix It & Quantifying Due Diligence

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