Private equity separate accounts and other alternatives to commingled funds raised nearly half the assets of traditional funds since 2007 as asset owners strive to gain control, manage returns and cut fees paid to private equity managers.
The trade-off for money managers is they must accept reduced potential earnings in exchange for managing larger portfolios for limited partners.
Separate accounts, co-investments and secondary capital raised up to $416 billion compared to $854 billion in traditional U.S. private equity funds from Jan. 1, 2007, through March 31, 2014, estimates alternative investment consulting and money management firm Hamilton Lane Advisors LLC, Bala Cynwyd, Pa.
“Since 2007, Hamilton Lane estimates that "shadow fundraising' in the U.S. — which includes between $250 (billion) and $325 billion committed in co-investment capital, between $60 billion to (and) $85 billion committed to separate accounts, and roughly $6 billion in secondary capital — represents about 50% (of the) ... cash raised by traditional U.S. funds over the same period,” said Andrea Kramer, managing director and head of Hamilton Lane's global fund investment team.
On a global basis, separate accounts have been on a jagged growth trajectory since 2010. In each of the past four years, the amount of money raised has exceeded that raised in 2010, which was $13.5 billion in 48 separate accounts at year-end.
In 2014, assets are $17.3 billion in 83 separate accounts as of Dec. 19, according to data provided by London-based alternative investment research firm Preqin. This year is down significantly from last year, when $35.2 billion was raised in 121 separate accounts, but in 2014 overall global private equity fundraising is also down as of Dec. 19 with $477.3 billion in 938 funds as compared to $530.3 billion in 1,195 funds at year-end of 2013.
Area of growth
Even so, separate accounts are expected to be an area of growth.
“Assuming LPs continue to believe that they get something unique and cheaper for their separate accounts, they (separate accounts) will continue to be a means for (general partners) to access additional capital,” Ms. Kramer said.
Suzanne Donohoe, member and head of client and partner group in the New York office of KKR & Co. LP, said a growing number of investors are seeking customized separate accounts.
“Customized mandates are definitely a trend across the industry,” Ms. Donohoe said. “At KKR we generally do them in instances where they are complementary to our traditional fund business or where they facilitate larger relationships investing across many of the asset classes that KKR invests in.”
Separate accounts are growing in importance, said Antony P. Ressler, chairman, co-founder and CEO of alternative investment firm Ares Management LLC, Los Angeles.
About 18% of Ares' $79 billion in total assets under management is in separate accounts.
“Over the past few years, large institutional investors have increasingly been requesting customized solutions from a single asset manager that can allocate across various assets classes in both equity and credit in order to meet their investment objectives,” Mr. Ressler said.
Bob Jacksha, chief investment officer of the New Mexico Educational Retirement Board, Santa Fe, said the pension fund invests in separate accounts, which are technically funds-of-one limited partnerships in private equity, real estate, infrastructure, natural resources and opportunistic credit.
Pension fund officials consider what works best and is most advantageous to the pension fund when choosing between a separate account and a commingled fund, Mr. Jacksha said.
“In some instances, size plays a role. The smaller the investment, the more likely we will use a commingled structure.” Mr. Jacksha said.
Adding to the flow of capital into separate accounts is the increasing number of private equity funds-of-funds managers that are offering them. Some 65% of private equity funds-of-funds managers indicated separate accounts would be as important or more important to their investment activity in the next 12 months than commingled funds, according to results of a Preqin survey released in March. Twenty-four percent of private equity managers said they invested more from separate accounts in the past 12 months than they had in the prior 12 months.
What's more, 23% of private equity fund-of-funds investors surveyed by Preqin that had not committed capital to a separate account in the past said they intended to commit capital to separate accounts in the future.
A big topic among investors is creating separate accounts that are longer than the typical 10-year lifespan of a private equity commingled fund. They are interested in longer lockups — with 20-year spans under discussion — in exchange for consistent returns and distributions.
“The topic du jour (in the separate account area) is that there are people who have large pools of capital who need liquidity on their own terms,” said Sanjay R. Mansukhani, senior manager research consultant in the New York office of Towers Watson Investment Services Inc., a subsidiary of Towers Watson & Co.
With longer-term separate accounts, managers that are creating consistent returns with a certain portfolio of companies would not have to sell the businesses because the commingled fund's time is up, Mr. Mansukhani said.
“With a 20- to 25-year fund, you can have a different profile. You can generate cash through investments. It doesn't have to be through sale,” Mr. Mansukhani.
Separate accounts also help large investors manage their return expectations, which drop as the amount of capital investors need to invest rises, he said.
“What investors are finding is that private equity is just like any other asset class in that it has a certain limit in the way it can deliver returns,” Mr. Mansukhani said.
The larger the investors' private equity portfolio, the more difficult it is to generate the same level of returns, he said.
Larger private equity investors have to invest larger chunks of capital at a time, which means they gravitate toward private equity managers investing in bigger companies.
One way of managing return expectations is by hiring a single manager, generally one with multiple alternative investment strategies, for a large separate account in exchange for a fee break.
“At a certain size, investors get declining returns and they want to maintain or slow the decline of return and one way to do that iswith fee arrangements,” Mr. Mansukhani said.
However, not all alternative investment managers want separate accounts.
“Most institutional investment managers desire discretionary accounts in the form of commingled funds as it gives the manager a greater ability to control investment decisions,” said Christopher Merrill, co-founder, president and CEO of Chicago-based real estate money management firm, Harrison Street Real Estate Capital LLC. n
This article originally appeared in the December 22, 2014 print issue as, "Assets invested in separate accounts starting to add up".