Building the foundation of strong GP/LP strategic partnerships
At the recent AIMA Global Investor Board meeting, the group explored GP/LP strategic partnerships, considering the following questions:
What makes a relationship truly strategic?
How can we make existing relationships with GPs more strategic?
How can allocators remain relevant to GPs, especially those growing very quickly and with so much access to capital?
At the base of things, being just a pool of capital is not a strategic relationship. Nor is an asymmetric relationship where allocators expect access, data, research returns and lower costs, though deliver back less in return. While one could argue all relationships can be views as strategic as allocators expect managers to deliver returns, many allocators try to differentiate strategic relationships where there are enhanced, global opportunities to work together across multiple jurisdictions, departments or asset classes. Often, this means that only 5-10 parties can be truly elevated to strategic partnership status that evolve organically over time.
Many allocators recognize have access to advantaged deals and engage accordingly in co-investments and directly, especially where managers have themselves advantaged deal flow and expectations of delivering strong returns. Deal flow can be easier for some on private equity vs. hedge funds, though many have done several direct coinvests with hedge fund managers (and real estate development, private credit, etc.) where there have been high conviction ideas and maximum concentration with the manager’s mandate was reached, so they have set up sidecars and allocated additional capital. For hedge funds, strategic relationships can be delicate to navigate as there can be fears of strategy replication. In public markets particularly, the time for an allocator to move into a trade can be too lengthy, whereby the arbitrage or opportunity may have passed before the allocator has a chance to capitalize.
For small teams, strategic relationships can help allocators broaden their reach and through COVID especially, they needed to rely on personal/professional relationships (strategic advisors, external consultants) when they couldn’t visit onsite or meet in person. Allocators need to rely on trusted partners to keep control on their open investment positions especially where they might not have many international partners (legal, tax, etc.), though this is an area where the AIMA global network can help as trusted partners across multiple jurisdictions.
Recently, it appears to allocators that larger managers seem to have a lot of options for fundraising and may be quite firm in the terms that they offer for access. These are not always favourable terms for allocators in terms of fees proposed for the value of assets under management. Larger managers sometimes seem to not be as interested in fostering a true strategic relationship, but rather may be motivated by the ability to name drop specific allocators. Large allocators feel that they can no longer rely on the position of being a unique provider of capital. Their size seems to be not quite as advantageous anymore, especially with large GPs raising funds of significant magnitude where it can feel like a fight for allocators to get access, especially in syndicated co-investments. Allocators can feel that if they don’t take the terms offered or allocate a truly large ticket (ie $500M-$1B), managers will go elsewhere, and thus the allocators feel their purchasing power has, in some ways, disappeared.
At the other end of the spectrum, it can be appealing for allocators to find their match with smaller managers. There can be a sweet spot with managers at $1B-4.5B in AUM as they find they truly act as partners, with allocations as little as $25M making a large difference for a manager. Allocators commended managers who truly committed to deep and stable relationships across funds and firms and worked with them find ways to invest in multiple projects. Some allocators have been willing to step in with more money when the manager needed it or seed additional, new products through partnerships, some blind and others once convinced of opportunity set. Where asset owners with long-term capital, can be great opportunity to have closer working relationship and provide liquidity and buy positions from managers as may be needed. Hedge fund managers can and have helped allocators with variety of strategic relationship benefits including access to data and research. In one example, a quant fund helped build out analytics which formed a foundation to analyze other managers. In another example, the junior allocator team shadowed manager to learn ins and outs of the strategy and running a fund.
Allocators need to be careful to make sure they maintain disciplined rules for trimming and exiting positions, should it be required, and that their fiduciary duty is not swayed by ancillary benefits or personal relationships. Calculating the true costs of the tangible and intangible benefits the allocator receives vs how that could be sourced in the open market is important and sometimes spreading these benefits out across multiple allocations to the same manager will better allow the allocator to trim or exit positions as needed without jeopardizing or losing the entire relationship.
Allocators need to also be cognizant of whether they are the largest or strongest partner in a deal, should they need to sell out of the position or end the relationship. They want to know what the manager is willing to guarantee or willing to do to save a deal vs. what’s solely outlined in the legal terms. While managers might commit to a strategic relationship, some don’t show up when the allocator really needs them. Allocators also need to be careful on exposures and that same co-investment opportunities are not offered to too many parties or across too many funds. Sometimes advisors will come out of large fund and start good coinvest opportunity (or convert into funds), though allocators have also seen fund of fund consultants fighting investors for allocations as if they control it.
Allocators are supportive of managers making money on fees, as long as returns are there. However, total fees can become a public issue, despite maximized net returns, since the unfortunate perception by media or by stakeholders from a governance perspective may be that the allocator paid too much for returns. While allocators support the manager earning their fees if allocator gets returns for beneficiaries, if that changes and they are not earning returns for investors, then the manager shouldn’t be compensated as well. During these tough times for managers, increased communication by the manager is important to ensure the relationship is not jeopardized in the long-term. The job of the investor is to make money for its investors which includes having to analyze and ultimately select what fund managers are going to do best for them without putting their investment at risk.
For allocators, other examples of strategic relationship benefits cited could include advice or consulting on specific topics like ESG, HR, digitalization of data and security. In return, allocators deliver to managers potential PR opportunities, consistent and dependable fees for managers and the possibility ability to add when strategies are down, under-performing and there is distress in the market(s). Managers can also benefit from coordinated and cross-functional service in navigating large organizations and having help to grow the relationship across multiple asset classes and regions, rather than what can otherwise be a decentralized or siloed approach.
It is clear there is an opportunity for both GPs and LPs to truly examine the meaning of strategic relationships and what great, balanced partnerships mean to each party.