EUROZONE: Position of strength

The fund management industry certainly does open itself up to criticism when it comes to poor governance.

Yet, over the summer, an example emerged of what seems like good practice and perhaps provides a blueprint for others to follow. Indeed, I hear two fund managers already have looked into the example to see if they should follow suit.

Legal & General, a UK insurance company with a good pedigree in real estate investment management, has taken an unorthodox approach to the potentially thorny issue of whether to extend or liquidate a fund due to expire in 2014.

The fund in question, the Industrial Property Investment Fund, has been going for 16 years, has more than £780 million (€907 million; $1.2 billion) in assets and some 90-plus investors, mainly advised by multi-managers.

For such a longstanding and largish fund, it would be human nature to want to preserve fee income by extending it. Normally, the general partner would have that outcome in mind and would speak to investors one by one to influence events. Divide and conquer, in other words.

Indeed, Legal & General did start talking to investors one by one last year, but it quickly found out that the limited partners each had slightly different needs. That is when the firm decided to deviate from the norm.

Earlier this year, Legal & General went forward with a plan to form an advisory committee and present all the options available to investors. Dan Batterton, business development manager at Legal & General Property, told those present – the fund’s seven largest LPs, representing most of the equity  – that the manager wanted to extend the fund as it believed the majority of its investors wanted to do, but that the firm wanted advice on how to do it.

It seems that, under the current guise of the fund, there is no contractual mechanism for investors to leave, which didn’t seem right to Legal & General or to the investors. Batterton also explained that the ability to raise new equity was highly constrained and that the general partner’s performance fees could only be paid when the fund had sold the last asset. So, if investors wanted to extend, that would reset the clock. 

Batterton went through all the options and opened the debate widely to incorporate what to do about fee structures, corporate governance and everything else that rightly should be reviewed when thinking of extending a fund. Though he knew many investors wanted to extend, he was braced for investors wanting to redeem and for demands over reduced performance fees in exchange for giving the fund renewed longevity.

Still, Batterton felt “empowered” by Bill Hughes, head of property, who had told him that, if investors wanted to shut down the fund, shut it down they would. Hughes had insisted that Legal & General is not in the business of protecting fee income, but of providing long-term investment returns.  “Rather than wind up the investors now for a short-term benefit, we will gain in the long term by keeping them on board,” Hughes had told Batterton.

So, in went Batterton to do the presentation. “I explained the issues and then I walked out,” he told PERE. Indeed, there was no one from Legal & General left in the room when the investors tossed around proposals for about two hours under guidance of the chairman from the board of trustees.

It became clear that the investors would have to compromise with each other on some issues but, after a lengthy session, the big themes were decided. Extend the fund they would and, by the way, they wouldn’t go after any change to the fee structure. As it turned out, they were happy with the longstanding arrangement.

Following that first big pow-wow, the investors had another two or three discussions to iron out the details as Legal & General had outlined some unintended consequences of some of the LPs’   proposals. They ended up with nine resolutions requiring unanimous consent, all of which received that consent.

There are a few lessons here for the industry. One, the multi-manager LPs proved they do provide added value for their double fees by offering expert guidance in matters of fund governance. Two, if investors have a large enough economic interest in a fund and the location is right, they will all sit in a room together to hash out proposals and make compromises. Three, it is sometimes better for a manager not to put the short-term gain of protecting fee income in front of doing what is right by investors in the long term. Four, the psychological effect of starting the conversation with ‘So, would you like us to shut down the fund?’ can be powerful.

Two other managers – Henderson Global Investors and Standard Life – face similar issues to the one Legal & General did one year ago, as they have two funds each that will expire in 2015. There are overlapping investors apparently, and those investors have recommended the Legal & General approach.

However, there is probably a fifth element here. It is questionable whether such an outcome would have been possible had the fund performance been poor. In fact, Legal & General’s industrial fund has outperformed its benchmark for all but one year, plus leverage is low. If it had been a different story, perhaps the manager wouldn’t have felt so empowered.