LP Radar: The LP-LP divide

The once harmonious LP community appears to be dividing into different classes, depending on how they invest. This disharmony has forced GPs to tread carefully in explaining why different LPs get different terms

Apparently, size does matter. In a recent conversation with a limited partner about the state of the industry, I was surprised to hear some grumbling about “fairness”.

The LP was peeved about some of the big headline-grabbing custom accounts built by large institutions and mega-GPs. The LP specifically brought up a custom relationship sealed last year between New Jersey’s state pension system and The Blackstone Group, in which $1.5 billion would be used in “tactical opportunities” vehicles that could invest across asset classes.

The LP’s point was that the pension was being afforded opportunities well beyond what smaller organisations could hope to get – including access to opportunistic deal flow and friendlier fund terms.

My feeling at the time was that this has always been the case – that the biggest LPs get the concessions because they get to sit at the negotiating table with general partners and hammer out fund terms. It seems only reasonable that those bringing the most money to the table get the most say.

The other thing was that for New Jersey, the account was a big win: the system got choice economics and a flexible mandate that would allow Blackstone professionals to jump on credit opportunities in the market (in Europe, say) without having to go through the process of raising a new fund for the deals.

However, while it’s true that size has always mattered in the industry, the feeling now among many LPs is that this is much more rampant among the many funds now hitting the market. “Size has always mattered,” admits one person with knowledge of the LP world. “But… it’s now showing up in the form of better economics more frequently. There’s much more acknowledgement that size seems to matter.”

The LP I talked to was expressing a dissatisfaction that is apparently being experienced by a good amount of LPs out there.

Mario Giannini, who as chief executive officer of consulting giant Hamilton Lane has a detailed view of the LP world, framed the issue at an industry conference recently. According to Giannini, the real tension today is not between LP and GP (as it has been for the past several years), but between LP and LP. The theory is that the LP world is fragmenting depending on how different investors view the asset class.

This makes a lot of sense, and is in fact perfectly rational. After all, why should the biggest investors in the market, who come into a fund with sometimes hundreds of millions of dollars, be concerned with an investor with a $30 million commitment?

Every LP in a fund ultimately looks out for their best interests, and that means fighting for the best economics possible. When New Jersey formed its custom account with Blackstone, it was looking to get the best return on its capital for the benefit of the state’s employees – whose retirement accounts depend on that return, of course.

Part of the “fragmentation” issue comes down to perception. The idea had been gaining a lot of attraction inside and outside the industry that LPs, for one shining moment, were able to come together in a sort of harmonious community, dedicated to fairness for everyone.

The creation of the guidelines published by the Institutional Limited Partners Association had something to do with this, in that they helped to foster a sense that LPs were working together.

But it seems that today’s tough fundraising environment has somewhat eroded whatever sense of cooperation had been forged after the financial crisis spun out of control and ILPA rose to prominence.

These days, GPs will go to great lengths to appease LPs who are willing to anchor their funds. The idea of signing on some big name investors to custom funds, in which capital is committed and even recycled for long periods of time, is very attractive to GPs – who know perfectly well that marketing new vehicles is not an easy prospect.

But this certainly has created some tension in the industry. According to LPs I have talked to about this issue, GPs have had to tread delicately when talking to their LPs, explaining both the merits of the separately managed accounts to big investors and the advantages of traditional funds to their smaller counterparts. This naturally creates some potential for awkwardness – for example, how should a GP present returns on a fund in which LPs of different sizes pay different levels of management fees?

One small institution LP described it as an awkward dance GPs have had to perform to keep everyone happy. Since separate accounts and different terms for different investors seem to be the way of the future, GPs are going to have to keep working on their moves.