Although separate accounts can bring in large amounts of investor capital for fund managers, some firms have come to the conclusion that they aren’t a good fit.
“Our view is that’s a great business for certain people and certain fund operators but, to do what we wanted to sustainably over a period of time, that didn’t work for us,” said Brahm Cramer, co-head of the real estate group at AllianceBernstein, speaking at the PERE Summit: New York 2012 conference on Friday.
“When we think about these separate account structures, what we’d be worried about the most is making good investments with our view of what’s going on in the market,” Cramer explained. But “there are separate account strategies that we feel to be backward, where it’s ‘keep buying, keep buying’ or ‘sell,’ and we don’t agree with that investment judgment.” Also, being tied to making certain types of deals based on an investor’s strategy would make it tough for a new fund manager to build a business, he added.
That said, “I think you’re going to see more of it, and there are some LPs who are incredibly capable of building that large infrastructure to deal with it,” said Cramer. While only a very small number of limited partners actually want to exercise discretion, “there’s large numbers of LPs who, notwithstanding that, still look to separate accounts to be able to time themselves in and out of the market and make decisions – maybe a personnel change or strategy change.”
John Noell, a partner at Mayer Brown, noted that his law firm works on 10 separate accounts per year –compared with just one per year five years ago – in addition to club deals and a variety of one-off hybrid structures. Still, not every large investor that wants to have a separate account can do so. Some sovereign wealth funds, for example, cannot invest through such vehicles because, for tax reasons, their capital cannot represent more than 49 percent of an account, he explained.
However, because fees are typically lower for separate accounts than for commingled funds, “it’s much more cost-efficient for LPs and, if they want to influence your exit, it’s a much better solution for them,” said Noell. However, the LP’s influence on an exit also decreases GP liability, he noted.
A fund manager also can be put in a vulnerable position if a separate account represents a significant portion of a firm’s business. “For the GP, the separate account can be a great way to get in business and start attacking a different strategy in the near term,” said Walter Stackler, managing director at Greenhill & Company. “But they’ve got pretty significant risk in terms of that one LP changing their mind.”
If a large separate account client decides to scale back on its allocation, then the GP is put under pressure to quickly find a new client to remain viable. Hence, the importance of also having a commingled fund business, which dramatically reduces that risk and is likely the more attractive investment vehicle for a GP over the long-term, said Stackler.
In lieu of separate accounts, some firms are looking at alternatives. AllianceBernstein speaks regularly with four or five key investors that sit on the firm’s investment committee. While the investors don’t officially have discretion, “we speak to them every two weeks, whether there’s anything going on or not,” said Cramer. “That’s fundamentally different from the way we operated five years ago, but it’s a very healthy change. It’s probably a middle ground between a separate account and a fully discretionary fund.”
Meanwhile, Noell is aware of at least one or two large commingled funds that offer investors discretion. “We’ve seen arrangements that are true discretionary relationships,” he said. “That’s an interesting in-between approach that we’ve seen.”