Follow-on commitments from investors are no longer a given for managers raising the latest vehicles in their fund series.
“Re-ups are no longer an assumption,” said Heather Fernstrom Border, co-founder and managing partner at Florida-based real asset consulting firm Alliance Global Advisors. “We’re not only in the most competitive capital raising environment, but the most competitive re-up environment.”
Follow-on commitment activity – which is now at its lowest point in two decades – began slowing down over the past year as investors grappled with market uncertainty. “When valuations went on hold and transactions went on hold and then pencils went down from an investment standpoint, that’s when everyone started to feel the pressure,” Fernstrom Border said. “Investors are going to wait it out as further write-downs are coming. This is causing the re-up discussion to heighten.”
Follow-on vehicles should be no more than 50 percent larger than the previous fund, added co-founder and managing partner Jen Stevens. “During the last two years, there was the assumption investors would automatically re-up in funds,” she said. But with the denominator effect leaving many limited partners overallocated to real estate, “you still had managers out marketing and raising larger and larger funds based on expectations of re-ups.” As re-ups have fallen short of expectations, those managers are now seeking new capital sources, she said.
“That has been a major focus of our investment manager clients – how do we build a best-in-class global distribution platform?” Fernstrom Border said. “When competition gets tight and we’re in a cyclical environment, that global distribution has to be as primed and optimal as possible. In addition, managers must build a resilient team to undergo market challenges.”
To help managers with global distribution, the firm has hired Leah Dillon as chief operating officer and head of partner engagement, in a newly created role. Dillon, who joins the firm on June 1, previously was a managing director in the client and partner group at KKR for three years, covering institutional clients and consultants in North America for KKR’s real estate platform. Prior to KKR, she was a senior vice-president at Prologis, working with European and Canadian clients for the firm’s strategic capital business and also held roles in real estate investment banking, asset management and capital raising at Sabretooth Capital Management, Macquarie Group, Citigroup Property Investors and AEW Capital Management.
As a global distribution specialist, Dillon has developed a network of alternative capital sources include high-net-worth investors, registered investment advisers, sovereign wealth funds and discreet capital providers such as large family offices and multi-manager channels. “New capital sources are emerging every day,” Stevens said. “Firms like KKR, Blackstone and Starwood are capitalizing on these new capital sources and structuring innovative products investors. Leah’s experience working with global investors will allow us to help other managers to do the same.”
According to Fernstrom Border, the most common reasons why managers fail to get a re-up include an unwillingness to negotiate fees; strategy drift; a lack of transparency; and underperformance. Additionally, investment committees are increasingly spending more time assessing the capital stack of the manager on the portfolio, asset and entity level in their due diligence.
An out-of-favor sector or strategy is also unlikely to get a follow-on commitment. “The strategy is not always relevant in today’s market,” Stevens added. “If you’re a manager out there raising capital for Class B office space, it’s probably not your time to shine. It’s a world of choice and not every strategy is relevant at this point in time.”