Friday Letter Don't 'give love a bad name'

An accidental musical interruption at the PERE Forum in New York this week could easily be seen to represent LP-GP relations over the past year. But where does the future funding model lay for LPs and GPs?  

Call it a coincidence or a sign, but when Bon Jovi’s “You Give Love a Bad Name” accidentally blared out of the speakers during a limited partner debate at the PERE conference this week, it prompted many chuckles and wry smiles.

There have been many conversations of late about the mutual frustrations (and, indeed, anger) between LPs and their fund managers. From the sheer lack of communication in some cases to tense negotiations over deal and fund restructurings, there are plenty of private equity real estate LPs (and possibly even GPs) who would argue they’d been “shot through the heart” , just like Jon Bon Jovi.

However, as the dust begins to settle, and all sides try to look to the future, a new question is beginning to emerge: where do we go from here? Is there no more love to occur within commingled blind-pool limited partnerships? Could the future really be separate accounts and non-committal club deal structures, as the talk would have us believe?

It was certainty an area of heated discussion on the final day of the PERE Forum yesterday. LPs want more “teeth”, as one panelist said. They want more control and they want their fund managers to have less discretion. They don’t want just one party wearing the pants in the relationship all the time.

However, simply moving over to separate accounts and club deals isn’t a panacea for what ails LPs.

Size is important. According to a poll of conference delegates, a majority believed plan sponsors had to invest at least $200 million to $250 million with a single manager in order to achieve proper diversification through a separate account. Many argued that it could even be higher with a price tag of $500 million minimum.

Smaller LPs could also be overwhelmed by the sheer scale of resources required to set up separate accounts and club deals in the first place. Do they have the staff, time and skills to conduct due diligence on all the real estate managers that come their way? And, if the investment opportunity is abroad, how much discretion do they want to take on board if they don’t have their own people on the ground? After all, not everyone is a CPPIB (Canada Pension Plan Investment Board) or sovereign wealth fund able to open an office in Shanghai, New York or London. Getting such investment models structured correctly, at the offset, therefore is more than just key – it is critical.

And we haven’t even begun to talk about investing in club deals with “like-minded LPs”. Just defining like-minded is another kettle of fish.

Yes, the industry will see some movement by LPs towards more separate account, club deal – and direct – investing. But the commingled, blind pool fund isn’t dead. It just needs tweaking. Asked what fund terms the industry will increasingly see in commingled fund documents in the future, one delegate shouted “all of the above” when given a choice between lower management fees, no fault removal clauses, catch-up removal, carry only after return of capital and portfolio-based waterfalls.

No one model will ever be perfect, but if LPs and GPs are open and transparent about exactly what they want from their investments in the future, the industry can start to move forward. Hopefully, next time a real estate bubble bursts there won’t be the lament that “you promise me heaven and put me through hell”.