For a very long time, it seemed the general partner was the puppet master. At the other end of the strings, the limited partner would dance. Such was the clamour to be involved in the real estate ‘show’ from 2003 to 2007 that LPs were happy to be controlled. They were told when an investment had been made, and would receive little more by way of information again once that deal had been completed. Indeed, the next contact would probably be another capital call for the next investment. In between, there was scant information provided by a good many GPs on the valuation and current performance of investments made, or factors that might affect the value of a property investment in the future.
Yet since then the puppets have decided they want to cut the strings, and not be left to dangle. They want to be alongside the General Partner. That is, they want to have a separate account structure, a co-investment or perhaps a joint venture in a club transaction.
This much is clear from data produced by PERE that was presented at our Global Investor Forum in Amsterdam in late October. Our in-house research team at PERE Connect spent time in September interviewing some 80 or so global real estate institutional investors to assess their current attitudes towards everything from strategies to preferred investment vehicles.
What did they find? A very significant shift in LP appetite. The preference of investors is moving towards JVs, separate accounts, and co-investments. In fact, future appetite for co-investments is almost equal to appetite for non-listed comingled funds.
With everyone having noticed this trend, it would be natural to argue that this new approach is limited to a certain type of investor – perhaps the biggest US and European LPs that are staffed up to the gunnels enough to cope with the demands of analysing an investment opportunity, valuing it, and executing it.
It is true that many LPs are not resourced enough to entertain anything other than a traditional structure. Fund managers are still raising comingled funds, so that much is evident.
Yet our sample of 8o interviews suggests that wanting control is something not just limited to one group. Though the vast majority of the investors polled were based in North America and Western Europe, LPs from emerging markets were also represented, predominantly those from Asia-Pacific. Furthermore, the investors were from across the spectrum from large banks with over $50 billion to family offices with less than $1 billion in AUM.
The findings suggest that JVs, separate accounts and co-investments are gaining popularity as LPs wish to go through this uncertain period with greater control and decision-making opportunities. Is this a bad thing? Well, for the investor perhaps not. As one multi-fund manager told me recently: “They are not only looking for control, but at the same time they want access to investment talent.”
Yet he also flagged up a shortcoming in the separate account model particularly, that hints at the shift being a potential pit fall for some fund managers. He said: “The battle will be which teams of investment talent will take the risk of aligning themselves with one source of capital.”
What risk is this? The fund of funds professional says he is aware of a number of situations where very good managers are being “really torn” notionally between accepting a big cheque from one party or whether to hold out for a fund.
If a GP is established and already has a robust fund management business with, say, €3 billion of assets under management, it might not worry him to assemble a €500 million portfolio for a separate account client. If anything, the €500 million would be a nice contribution to the business and a welcome diversifier.
However, if an emerging manager with less than €100 million of assets under management accepts and builds a €500 million portfolio for the client, would that be so good? It could be seen as a great way to kick-start a programme and provide an immediate source of revenue. But the danger for the manager with a high proportion of assets under management being ‘controlled’ by one party is self-evident.
At the end of the investment programme, the investor in theory could decide that he is done. Worse, half way through building a portfolio, he might decide to scale back the rate of investment and even to shift allocation away from that particular strategy. Perhaps the investor has examined its credit portfolio and is seeing something scary. He might even negotiate an early exit from the arrangement if he suddenly needed liquidity.
For the above reasons, the debate about control is at its keenest for emerging managers and they tell me this is an area of great concern. LPs might not want to be puppets on the end of a string, but neither do GPs.