What investors think about strategy drift

What happens when a specialist manager no longer wants to specialize?

Meyer Bergman, which has focused on the retail sector since its inception 14 years ago, is now planning to expand into industrial real estate, PERE reported late last week. The London-based private equity real estate firm hired its first executive to pursue logistics investments in Europe and is understood to be close to completing its first deal in the sector.

In making the move, the firm is the latest sector specialist to branch out into other strategies. GLP, a real estate investment manager best known for logistics investments since its founding in 2009, is another example. It made forays into both the infrastructure and private equity sectors earlier this year.

Venturing into new sectors inevitably raises concerns about strategy drift, which has long been considered a red flag for many investors. More often than not, the expansion into new strategies is in the interest of the general partner, rather than the investor, and yet it is the investors’ capital that is predominantly at risk if the new venture proves unsuccessful, one investor told PERE.

One way some managers have justified these expansions is to classify them as “adjacencies” that support their core investment strategies. That was precisely the rhetoric adopted by GLP.

GLP is investing in solar energy generated from the rooftops of its warehouses via its infrastructure platform and in technology companies that would help improve efficiency in the logistics industry through its private equity business. Both types of investments, the firms says, are intended to ultimately benefit GLP’s core logistics portfolio.

Similarly, Meyer Bergman has made non-retail investments linked to its primary property type. Last-mile logistics facilities have an obvious connection to retail properties, and the firm previously has invested in mixed-use properties such as London’s Bond Street House and 663 North Michigan Avenue in Chicago, where tenants in the non-retail component could potentially bolster demand for the retail component of the asset, it says.

But even when a new strategy could be considered an adjacency, some investors frown upon it all the same. For one thing, there may already be plenty of managers with products available to them that specialize in that adjacent strategy. Secondly, even when strategies appear complementary, they in reality often require different skill sets to successfully execute and manage – and while some skills are easily transferable when moving into a new investment type, some are less so.

That said, strategy drift is nothing new in private real estate and an investor may be willing to give a manager a pass under certain circumstances. One investor said it thought highly of a certain specialist firm it had previously backed that was expanding into new sectors. Among the reasons he cited for continuing to support the manager were the fact the firm has had a very strong track record, has a differentiated strategy and is adept at sourcing opportunities, particularly in markets where it is difficult to execute on transactions.

Still, the manager’s strategy drift did give the investor some pause and he noted it would have been ideal if the manager had been more upfront about its investment change and also offered to charge lower fees on its investment in the new strategy to help offset the greater risk involved with the deal. He added the style drift would be a factor he would think “long and hard” about as his organization considered making a follow-on investment to the manager, which is now in the market with its latest fund.

Indeed, as with any material changes, communication with investors, as early as possible, about shifts in strategy is critical to maintaining their support. Another investor with the same specialist firm said he had yet to have a dialogue with the above-mentioned manager about its new strategy plans.

For some investors, what is arguably most worrisome about any manager’s strategy drift is not the change itself but being unaware it was even coming.

Contact the author at evelyn.l@peimedia.com.