Friday letter: Making partnerships work

In the alternative investment world, separate accounts continue to proliferate. Investors need to be mindful of the risks.

Strategic partnerships between large investors and multi-strategy asset managers, often structured as separate accounts, are on the rise. They often result in the investors committing large chunks of cash – $1 billion or more in some cases – for deployment via several strategies as opportunities arise.

Alternative credit managers can invest these assets across different types of collateral, vintages and market cycles. And large money managers with a diverse set of investment capabilities can broaden the scope even further to include credit, private equity or hedge funds. Think Blackrock, Blackstone or Apollo. 

On the surface, this sounds like a great idea for the LPs and the managers alike. The investors get better economics on their capital, preferred access to the managers’ deal flow and, in theory at least, investment advice on their overall portfolio. The managers get large chunks of capital; fundraising becomes a good bit easier.

The question is how these partnerships are structured. When and how do managers decide to deploy the capital, and when do they start charging fees on it – at the point of capital being committed or invested? When the sums get this large, alignment of interest becomes ever more important.

One well-known example of a pension plan that lived to regret a foray into partnerships is the $30 billion South Carolina Retirement System. Prior to Curtis Loftis, the current State Treasurer, taking office in 2011, the plan committed nearly $7 billion to a variety of private equity, opportunistic credit and hedge fund strategies managed by firms including Morgan Stanley Investment Management, Goldman Sachs Asset Management, Mariner Capital Group and Lighthouse Partners.

Loftis found the fees being paid exorbitant and the returns underwhelming, pushed out the CIO and worked to reduce the pension plan’s exposure to alternative investments and strategic partnerships.

The South Carolina Retirement System Investment Commission (RSIC) continues to reject Loftis' criticism.

There have been no official measure against individuals involved, but in hindsight it is clear that South Carolina didn’t have a good experience. The same can be said of the Libyan Investment Authority, whose falling out with Goldman Sachs over the latter’s handling of certain LIA assets continues to make headlines.

For all other investors, these stories should make interesting case studies. From a capital allocation point of view, separate accounts are an efficient way of investing the very large sums that the world’s biggest investors are having to deploy. From a performance point of view, however, the jury is still out on them. And adequate structuring on the way in is essential if disappointment is to be avoided later on.

This piece was updated on 3 November to reflect that there are no continuing investigations into the South Carolina Retirement System and the position of RSIC.