One size doesn't fit all

When Marc Mogull, founder of London-based Benson Elliot Capital Management, stood up before delegates at the PERE Forum: Europe 2008 in London last month, he knew his comments would be controversial. He wanted them to be. Reigniting the debate about the relationship between general and limited partners, as well as corporate governance principles and guidelines published by the European Association for Investors in Non-listed Real Estate Vehicles (INREV), Mogull wanted to call attention to what he argued were the dangers of a “one size fits all” approach to reporting and corporate governance. A snap poll of the audience revealed that most people agreed with the thrust of his comments. Here, in an abridged version of Mogull's speech, the founder of Benson Elliot sets forth his views on the general partner-limited partner relationship, and why the INREV guidelines are not for him.

“What an interesting time to be talking about GP, LP relationships. Everyone has a view on this topic, and everyone thinks theirs is the right view. It is a bit like watching [Hillary] Clinton and [Barack] Obama supporters square off. There is a lot of smug righteousness, but far less unemotional objectivity. Certainly little consideration of shared interests. Let's start with what LPs really want, or should want, from their GPs. I'd argue it boils down to three things, in order of importance: mission integrity, performance and insight. By mission integrity I mean up front candor and clarity in describing fund objectives, risks, investment philosophy and approach. Thereafter, it means sticking to the strategy and implementing the approach you said you would. LPs hate surprises, and they hate style drift.

“Performance is obvious. LPs want GPs to make them money consistently and with due regard to risk. The question for LPs is: “How do I assure myself I am going to get performance?” This brings me to the third key thing LPs need from their GPs: insight. LPs have a fiduciary duty to monitor their investments, in the same way we have a fiduciary duty to manage them. But would put insight a step below performance, and for good reason. Because monitoring is not an end in itself, its goal is to confirm mission integrity and to deliver performance. Confirming the ailment of a patient you've killed in diagnosis is a pretty hollow achievement.

“Performance monitoring and corporate governance have become hot topics in our industry, particularly here in Europe. It's where I as a GP begin to swim away from the mainstream of the European community. First the good bit: I think inclusiveness in managing relationships with LPs is more than good – it's essential.

“Now don't get me wrong. I've got plenty of time for INREV, its mission, its members and its leadership. In terms of educating LPs, developing standards for the bulk of the real estate fund management industry and providing a forum for the ongoing exchange of ideas is mission critical.

“But, whereas INREV's reporting guidelines explicitly state that: “These guidelines are most relevant to funds which are closest to a core strategy, and are not as appropriate to funds which have a highly opportunistic' strategy,” the corporate governance guidelines make clear that the definition of fund “includes funds regardless of their investment style, that is core, value added or opportunistic.”

“The most successful LPs figured out long ago that managing opportunistic and core managers the same way makes as little sense as trying to manage an R&D department in the same way as a production line. Transparency is good. Alignment is good, but standardization? Not for an industry that's so heterogeneous. Because GPs and mandaes come in all shapes and sizes, a one-size fits all approach to monitoring and reporting can't make sense.

“So beyond definitions, what is it about INREV's Corporate Guidelines that gets me worked up? Well, their report identified three key issues. The first: “Investors are concerned about the lack of transparency and market information on some non-listed real estate vehicles.”

“As I just said, it's hard to object to that. The devil is in the details, of course, but I've acknowledged that insight – an ability effectively to monitor investments is, and should be, a key investor requirement. At Benson Elliot we provide our investors with access to every shred of information we have at our own disposal, but in the format we use it internally. Nothing is created just for investor reporting purposes.

“The second issue: INREV has identified “the need to ensure a true alignment of interests between themselves and managers.” As I said, an LP's ultimate performance security lies in alignment. So I have no problems there either, except that alignment has disappeared from many GP-LP relationships. LPs have to acknowledge that, and manage around it. Structures that encourage GPs to act in the interests of LPs are a far better approach to managing the GP-LP relationship than standardized and stifling control regimes. But sadly, even a 10 percent GP investment, in a fee-laden fund sponsored by a manager trading at 15x earnings, isn't alignment. It's instant shareholder value.

“The third issue INREV identified: “A significant majority of investors acknowledged that good corporate governance would involve having a non-executive body operating from within the fund to represent their interests.” That is the wrong answer. Not in our fund it wouldn't, and frankly, not in any private equity real estate fund I know of – large or small. Here's where we get to inclusiveness. I have an inclusive relationship with my wife, an intimate relationship even. But it doesn't include any of her friends, consultants or otherwise. It's one-to-one, it's direct. It provides for rights and responsibilities on both sides. To me, that defines the GP-LP relationship. Yes we're the fiduciaries, and that endows our investors with rights. But this is a democratic relationship, and, to quote author Norman Cousins, in a democracy, the individual enjoys not only the ultimate power but carries the ultimate responsibility.” In our case, that responsibility is direct LP engagement and bespoke oversight. Yes, this may place a burden on our LPs. It requires an active approach to managing their Benson Elliot relationship. That's the way we like it. We want to feel special.

“But it doesn't mean reports prepared to educate a succession of consultants, juggling multiple assignments, who can never really understand what we're doing and how and why we're doing it, in the limited timeframe their modest fees permit; it doesn't mean “he said, she said” games; it doesn't mean posturing, backside covering and agendas of third parties – call themnon-executive directors, consultants, or anything else.

“Reporting is an asymmetric business. It is much easier to demand than to comply. We force our LPs into a close relationship with us because that benefits us. Our interests are aligned, and only if our LPs are fully informed can we avoid the kind of mechanical questioning and information gathering that wastes our time and our investors' time. Our investors worry less about information gathering, and more about being informed (and, of course, performance).

“For some LPs that won't work. They've got too many GP relationships, or too much money, or too many rules, or too little time, interest or experience. We're not interested in those LPs. Which is fair, because they're not interested in us. We favor relationships that are truly inclusive. Relationships that are principal to principal.

“This brings us back to the power game. Record fundraisings in the past year would support the view that market-leading GPs are holding all the cards right now. That may be, but don't count the LPs out. History has taught us that these things can change. In the US, LPs are increasingly finding themselves over-allocated to real estate. The denominator problem is kicking in, and flowback from earlier fund commitments has slowed to a trickle. That means there may be less money available next time we all pass the hat around.

“In Europe, INREV has given LPs a forum in which to disseminate best practice and compare notes, but it's also enabled unionization. Collective bargaining can't be far behind. Finally, no one expects the performance of the next ten years to duplicate the returns of the last ten. Lower returns will inevitably put more strains on the GP-LP relationship. So far, the disconnect between European LPs and leading GPs has been mostly harmless. LPs explain their principles, snub best-in-class GPs (or quietly make exceptions), and then go beat up on smaller guys who actually need their money.

“This is the institutional equivalent of big kids bullying little kids on the playground. Unfortunately, it makes it harder for start-ups to attract talent, depriving LPs of the hungry new players to set against the goliaths with whom they've lost alignment. But ignoring each other, or thinking we can carry on indefinitely without reconciling different views, are both shortsighted. We have to reach a point where LPs can feel they've got effective control and oversight of their private equity real estate investments and managers even where alignment has been lost, but enable GPs to maintain the kind of structures and entrepreneurial environments that will continue to attract top talent and deliver performance.” INREV was unavailable for comment.