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Can the direct model be replicated in the US and Europe?

PE Hot Topics - August 2017

Limited partnerships (LPs) continue to seek ways to minimize the costs of their alternative programs. Anecdotal evidence suggests that some are exploring direct investments as a potential solution. Can the direct investment model work for investors in the US and Europe?

The impetus is real

The last decade has seen tremendous growth in private equity (PE). Once a niche asset class, the importance of PE and other private market investments in institutional portfolios has grown dramatically in recent years. And with cost pressures rising, the direct investment model is surely tempting. For investors mulling direct investment programs, there are a number of key learnings they can take from those that have forged the path:

The development of a successful direct program takes time

Investors currently active in direct investment programs didn’t establish their programs overnight — they built teams over significant periods, learning as they went and evolving the model along the way. Many began with commingled funds, increased their involvement with co-investments and eventually built out direct investment capabilities complete with sourcing, deal teams and operational/value creation professionals.

I don’t think there’s a secret sauce to their success. People look at these funds doing direct investments and think it’s an overnight success. But it’s not something they’ve turned on overnight, they’ve grown it steadily over a long period of time."

– Tim Piggott, Partner Transaction Advisory Services, Ernst & Young LLP

It will require cultural changes in the way investors view risk...

One of the biggest barriers to adoption of the model in the US and Europe is cultural. Having the right governance structures in place is a key enabler. Boards need the ability to provide effective oversight without overly constraining investment capabilities.

… and the way they recruit and compensate talent

Perhaps the most commonly cited challenge to starting and maintaining a direct investment program is attracting the right talent. But the gap may not be as large as many think. And when you factor in the additional benefits — freedom from fundraising pressures, the potential for greater alignment with colleagues and a strong sense of civic contribution — it's easy to see why there exists a cadre of top-level dealmakers attracted to the opportunities.

However, the opportunity is substantial

With today’s bull market, the second-longest on record, investors are bracing for compressed returns across all asset classes in the coming years. As such, the need for high risk-adjusted returns delivered in a cost-effective manner is perhaps more urgent than ever.