GP policies under increasing LP scrutiny, says EY

According to EY, the current market uncertainty has led to increased investor scrutiny over GP talent management programs, ESG policies and reporting, against a backdrop of regulatory reform.

In light of the global economic volatility following the Covid-19 pandemic, the outbreak of war in Ukraine and rising interest rates, EY’s most recent 2022 Global Alternative Fund Survey projects at least a constant, if not increase, in LP allocation to PE, benefitting from short-term market dislocations and long-term capital growth.

However, LPs are in turn demanding more from fund managers and keeping a closer eye on GPs’ internal processes.

The survey polled 61 institutional investors and 112 PE firms predominantly across North America, but also Europe and Asia-Pacific. The AUM of the managers interviewed ranged mainly from $2bn to more than $10bn.

Responding to market risk
Macroeconomic headwinds are a particular concern for LPs and GPs, with 70% and 64% respectively of those surveyed anticipating a global recession in the next 12 months.

According to the report, the ongoing uncertainty has pushed fund managers to adopt a longer-term approach to their business propositions, in an attempt to ride out the storm. With that comes a heightened awareness of flexible and thorough risk management, with an ability to adapt to the multiple, unpredictable hurdles the economy faces.

Measures include financing long-term growth objectives, creating and maintaining viable relationships, and distributing strategic insights firm-wide. Retaining company culture and facilitating employee opportunities are also at the forefront of GPs’ risk management strategies.

Talent management
LPs are scrutinising GP talent management, particularly DEI programs alongside ESG policy and reporting. More than half (55%) of investors surveyed stated an increased level of talent-related scrutiny, while 75% of fund managers said that talent retention was a primary objective.

Fund managers are deploying talent retention programs to mitigate turnover by increasing compensation, emphasising diversity and inclusion, prioritising flexibility, and increasing job opportunities for employees.

Furthermore, the industry’s post-pandemic workplace flexibility policies are changing, with firms balancing employer aspirations to return to the office against employees’ desired hybrid approach. Almost 60% of GPs have a target for their workforce to be in the office three or four days a week.

Increased ESG scrutiny

SEC’s increased climate disclosure proposal for public companies implies LPs will assess their fund managers’ ESG policies in more detail.

Many larger alternative investors are now required to meet specific environmental and social commitments, or will be soon, according to the survey: 14% are required to invest in these products and 29% anticipate this becoming a requirement in the next few years. Top concerns include governance and climate risk, followed by human rights and DEI.

It is a real possibility that GPs risk losing investors if ESG policies are not met, according to the survey: 26% of LPs have decided against an investment due to insufficient ESG policies in 2022, a 5% increase compared to the 2021 survey.

In response to the growing appetite for transparent sustainability reporting, private equity managers have embedded ESG into investment decision-making and governance structures, with 56% of PE managers reporting on these initiatives.