The joys of separation

Separate accounts continue to grow in popularity for many limited partners seeking access to debt or credit markets. Since covering the issue extensively in our May issue, several US pension systems have allocated significant amounts of capital to managers such as Ares Management, SEI Investments and Oak Hill Advisors.

Over the last two months alone, The Pennsylvania Public School Employees’ Retirement System (PSERS) established a $100 million separate account for collateralised loan obligations with SEI. The Los Angeles County Employees Retirement Association allocated $200 million each to accounts managed by Ares, Beach Point Capital Management, Oak Hill and Sankaty Advisors for investments across a variety of opportunistic corporate credit strategies. Finally, San Bernardino County considered accounts for Oaktree Capital Management and Ares that would allow the firms to invest across their respective platforms.

Such investors are taking an intelligent step. Separate accounts offer limited partners several benefits – namely more favourable fee structures and better alignment with their management teams. Many of the accounts mentioned above also give the pension funds the right to veto certain investments if they feel they don’t pass muster, or are a poor match for their portfolio.

They aren’t entirely without risk, however, particularly in the case of smaller pension systems or endowments. Overweighting on individual strategies has inherent risks, but so too does placing too much of a burden on a single manager to generate returns. From a manager’s perspective, they’re also resource-intensive compared to a fund, and risk antagonizing other LPs.

The preference to cull their portfolios down to a manageable number of relationships remains a predominant theme within the alternative industry at large. With private debt a relatively new entrant – at least in terms of public pensions establishing separate allocations – it appears as though LPs do not wish to make the same mistakes they made with the private equity boom (i.e., allocating too much capital across too many fund managers), which created an unsustainable work load for their investment teams.

“We have experienced the opposite problem historically,” one limited partner told Private Debt Investor. “Previously we made the mistake of placing our strategy with too many managers, generally losing focus through over-diversifying the portfolio, as well as not monitoring our managers as closely as we should by spreading ourselves too thinly.”

One thing is certain: separate accounts are here to stay.