Friday Letter Graveyard shift

The final, official demise of two alternative asset managers this week raises a number of important questions, but here's one especially occupying the minds of investors: how do you retain and reward the team charged with winding down a moribund manager's portfolio?  

This week the bell tolled for two formerly heavyweight alternative asset managers: buyout group Candover Partners in the UK and private debt specialist GSC Group in the US. The former announced that it would continue life only as a realisation vehicle, winding up its portfolio and returning cash to investors. The latter filed for bankruptcy, saying it would be selling off anything it had left that was of value.

Both situations will be lamented, documented and pored over for their significance for managers, investors and the broader industry. But what will be of most concern to the limited partners in funds managed by these broken firms is how the remaining assets will be managed and some value realised.

In situations such as these, the normal rules for manager-motivation have to be recalibrated. The prospect of generating carry is wholly remote, while any hope of raising a next fund has plainly gone out the window too.

For GSC there is the relative predictability and systematic regime that Chapter 11 proceedings bring. The job at hand is to realise value from the funds that remain. The senior management have also been working hard to map a future for themselves with another asset manager, with Black Diamond Capital Management appearing the likely winning bidder. Meantime, GSC will look to sell “substantially all of their assets with economic value”, senior managing director and president Peter Frank said in bankruptcy documents.

In the case of Candover the task of mapping the future has fallen to the listed parent company – Candover Investments – which will support the ongoing personnel costs of Candover Partners to the tune of £12.5 million (€15 million; $19 million). These costs would otherwise have been met by fee income from the aborted 2008 fund.

Remunerating and retaining personnel to realise the value in the portfolio is a sensitive area. One anonymous LP – a pension fund manager invested in Candover 2005 – reacted to the arrangement with anger: “What grates most of all is that the team seems to need close to £1 million in retention bonuses per investment professional from Candover PLC just to encourage them to hang around to manage the fund,” he complained to PEO.

“To an investor in the 2005 fund, sitting on near 50 percent losses you could not get a clearer illustration of the misalignment of interests in the industry,” he added, summing up the situation thus: “Heads: I win. Tails: I don't give a monkey's – unless paid to do so”.

His resentment may be understandable, but also a little misguided. The £12.5 million earmarked for retention pay, for example, is not just being divided up between the 14 members of the investment team; it will go towards running a firm with 39 staff.

The fact remains, though, that some LPs – and many public shareholders of Candover Investments – will be left with a sour taste in their mouths. If this is the team that got the funds into a hole, why should they be retained at all? Why should they be enriched, when investors' capital has been eroded? Surely the assets could – and should – be transferred to a new manager with a more motivated and resourced team?

But as another, more sanguine, Candover LP put it to PEO, any actions taken were designed to protect the interests of investors. To extract the value of what is left of LPs' investments, the team needs to be both retained and motivated. These are the people, after all, who know the portfolio best.

And in this instance, says the sanguine LP, “the group retained were the best of the bunch”. Barring a couple of talented, more junior, leavers, the team that stayed “were the guys with the most energy and the most enthusiasm”. As a spokesman for Candover put it, the remaining team has “worked hard on the portfolio over the last 18 months or so – not only do they have scars on their backs, they have tattoos too”. Lining up a new team – which would be unfamiliar with the assets – would itself cost money and may not be any more effective.

To an investor nursing some heavy losses, the thought of more money being channeled to an investment team they see as culpable may seem unpalatable at best. The question is, however: is there a better option?