Talent turbulence

For a case study on the difficulties of retaining fund management talent, look no further than GLG Partners. On paper, the London hedge fund has adopted all the best practices for retaining key executives. Its portfolio managers enjoy a significant amount of the profits they create. On top of that, the firm went public on the New York Stock Exchange last November, ostensibly as a way to create further equity incentives to retain talent.

All this did nothing to retain Greg Coffey, a star trader who oversaw some $7 billion (€4.8 billion) in emerging markets funds. He is expected to start his own firm, and in so doing, to potentially drain billions from GLG as investors transfer their capital over to Coffey's new fund. In resigning from GLG, Coffey reportedly left $265 million in cash and shares on the table.

GPs everywhere in the alternative investment space have a habit of ditching firms founded by somebody else, and just when things are going really well.

Ambitious investment professionals go bonkers when they feel they don't have a meaningful say in how the firm is run.

In this respect, the buyout market is a bit more mature than the private equity real estate market. This is most evident in the near Biblical way that firms have proliferated (Lehman begat Blackstone, Blackstone begat Silver Lake, Silver Lake begat Elevation, etc.) The near-constant churning of personnel amid the ranks of private equity GPs over the past 20 years has produced hundreds of new firms, some of them now among the largest in the market.

Now, the surge in real estate allocations is bringing an inevitable wave of spin-outs to the real estate industry. As you'll see in our feature in this issue on emerging managers (“The Young and the Restless,” p. 31), most of these firms are led by people who cut their teeth at established firms. For example, as PERE went to press, news emerged that Starwood Capital senior managing director Merrick Kleeman will leave to launch his own firm, called Edgartown Capital Partners. Why doesn't Kleeman, and the many other defectors before and after him, just stay put? Two reasons: economics and control.

Most turnover, of course, boils down to compensation. It is a rare founder who gives up enough economics to truly handcuff a star employee to the franchise. Junior partners are acutely aware that, although they may enjoy large bonuses and carry payouts in good years, they are not capturing a significant share of the economics that accrue to the owners of the management company. You can't take your bonus public or sell it to the Abu Dhabi Investment Authority, for example.

A related problem between founding partners and top-performing employees is control. One hears this from headhunters again and again: It's not just the money – ambitious investment professionals go bonkers when they feel they don't have a meaningful say in how the firm is run, how the investment vetting process is structured, how the portfolio is managed.

There exists in the alternative investment industry a handful of firms that seem to expel talented employees on a regular basis. The problems with these turnover-plagued groups often boil down not to economics, but to control, and a stubborn founder is usually to blame. It is one thing to bring top performers into the partnership pool. It is another thing entirely for a founder to relinquish management of the firm to people who didn't put in the decades building it. It's a voluntary ego downsizing that many successful entrepreneurs can't accomplish.

The spin-outs endemic to alternative investment firms are a real headache for investors, who after all back teams of GPs over long periods of time. It forces LPs to ponder whether they are actually committing to a group of individual investment professionals, or to a “firm,” with its structures, systems and culture. In reality, they need to back teams that have both talented people and sound structures in place.

As the private equity real estate industry continues to mature, it will become evident that some firms are led by founders with a talent for deals but not franchise-building. While all firms suffer some degree of turnover, the ones that will ultimately be led by a next generation of talent will have created a structure that rewards talent with both economics and control.