Circle of trust

One LP is relaxing its ‘re-upping’ approach to trusted real estate fund managers but others fear it setting a dangerous precedent.

In the movie Meet the Parents, Robert de Niro’s character Jack introduces the concept of ‘the circle of trust’ to future son-in-law Greg, played by Ben Stiller. “I keep nothing from you, you keep nothing from me,” Jack explains, “and round and round we go.”

One LP featured on this week is looking to put some GPs in its own circle of trust when it comes to repeating equity commitments, or ‘re-upping’.

The Nebraska Investment Council approved a measure giving its investment staff more independence when it comes to making repeat equity commitments to the follow-up funds of certain of its private equity and real estate fund managers. The new protocol enables the $16.8 billion system’s staff to make these re-ups without having to wait for fresh board approvals.

For Nebraksa, this autonomy is given under the following conditions: Firstly, when previously agreed upon or optimal fund terms are being offered; secondly, if the commitments are limited to around $25 million; and thirdly, if they remain consistent with its annually determined asset allocation.

It is worth mentioning Nebraska is not alone in doing away with aspects of its repeat commitment due diligence. The New York State Teachers' Retirement System (NYSTRS) is another example to have adopted a similar policy. Its executives sill engage in due diligence on re-ups for follow-up funds, but in these instances, they are granted greater autonomy to make investments, again provided the dollar amounts involved do not exceed certain thresholds – typically $25 million to $35 million, PERE understands.

So why do these investors do it? Each will have its own rationale but one notional advantage for fast-tracking approvals, particularly for opportunistic real estate vehicles, is stealth. In theory at least, expediting the process of getting capital working quickly can be important for capturing value during limited windows of opportunity.

Yet many LPs are not rushing to do away with this bit of protocol. Some say removing the need for board approvals, regardless of a firm’s track record or whether its vehicle meets predetermined predicates, could set a dangerous precedent both for the individual investor and the wider investor universe. Increased due diligence by investors is a characteristic to emerge thanks to recent dire fund vintages after all.

Just one danger of ‘rubberstamping’, as one LP put it, is that it could overlook changes within the GP. On the surface, Fund III might look no different to Fund II but if there have been significant management changes since the last fundraise, an LP might want to reconsider re-upping. 

One LP in the ‘against’ camp is the California State Teachers’ Retirement System, which this week re-upped with five managers to the tune of $1.2 billion. CalSTRS does not distinguish between re-up and fresh commitments when it comes to undertaking its due diligence. For the California pension, each type is subject to the same scrutiny.

There is reason for and against cutting protocol in regards to making repeat commitments to investment managers. For the moment, it seems not every investor embraces Nebraska’s new approach and the chances are this situation might not alter overnight.

In the meantime, the best advice for managers is to keep up full and open communication with their investors. Whatever the due diligence protocol, that is surely the best way to ensure managers fortunate enough to be so demonstrably trusted go ‘round and round’ with their backers and don’t find themselves on the outside the circle.