General Partner and Investor Perspectives and the Investment Process

Traditional fund managers analyze investments based on publicly available information, readily buy and sell publicly traded securities in a portfolio, and are usually compensated by investors based on a fixed percentage of assets under management (AUM). Public fund investors can easily compare relative risk and return among similar fund choices and trade these positions with few transaction costs. In private markets, underlying investments, as well as the methods and structures used to attract capital, manage assets, and distribute returns, give rise to very different interactions between private fund managers or general partners (GPs) and private market investors or limited partners (LPs). This reading addresses the unique relationship between GPs and LPs over the investment life cycle and the private market investment process.

According to Preqin, an alternative data provider, private market AUM globally are expected to rise to USD18 trillion by 2027, or more than triple their level from a decade earlier, due to higher potential returns and diversification opportunities. Private markets, such as private equity, private real estate, and unlisted infrastructure, are characterized by an investment life cycle with negative cash flows and/or high leverage during an initial period of development or transformation. This process requires more active manager engagement and specialized knowledge to evaluate cash flows and risks. Investors often must commit capital well in advance of deployment, hold investments for several years, and receive returns with distributions of uncertain magnitude and timing over a multiyear holding period.

In this reading, we first examine how the features of private markets define the roles and responsibilities of general partners of private funds. Differences in private manager compensation approaches and risk and return measures are two important investor considerations addressed in the following section. We then focus our attention for the remainder of the reading on the private investment process itself, including the following elements:

• Alignment of GP and LP interests over the investment life cycle and private market fund performance from an investor perspective
• Features of attractive private investment targets, economic value drivers, and sources of value creation in private markets
• Key components of due diligence and the business plan applicable over the period of development or transformation of a new or existing property, asset, or privately held company
• Determining the appropriate exit timing and method of a private investment to maximize return to investors over the holding period

The private market features and structures from the first reading combined with the GP and LP perspectives and investment process from this second reading create the foundation for a more detailed survey of individual private market asset classes and their role in strategic asset allocation in subsequent Private Markets Pathway readings