Large LPs want a special relationship

Separate accounts are all the rage, for good reasons.

Everyone’s at it: New Jersey with Cerberus and Blackstone, Texas Teachers with Apollo and KKR, an unnamed sovereign fund or two with Terra Firma… Special managed accounts are seemingly the way forward now whenever a large institution wants to put a large amount of capital into private equity.

To general partners, a special account can be a shortcut to a big cheque. It’s not surprising that some of the biggest names in the business have been offering them to large clients. True, the economics may not be as compelling as with a traditional fund, and the administrative burden is likely to be greater. But in today’s environment, GPs hunting for funding clearly don’t see these points as deal-breakers.

For big limited partners, these special relationships make life much easier. They’re the key to lower costs and fewer relationships, and they also adjust the balance of power  – not before time. If you’re an investor with a big helping of capital in a separate account, you have some additional leverage, and certain problems will be less likely to arise as a result.

Take the dreaded “zombie” fund phenomenon, for example. A new survey from Coller Capital, released earlier this week, found that about 50 percent of investors were exposed to funds where the GP had no prospect of earning carry and was merely prolonging the fund’s life to generate management fees. Worse, only 6 percent of those LPs with a “zombie” problem thought they would be able to find a solution.

Now just think: if they were the only LP in that fund, rather than one of many, would they still feel so helpless? Hardly. They’d be so much more likely to bury their “zombie” once and for all. With managed accounts, because they're a one-to-one arrangement, there's much less chance of interests getting out of alignment and investors getting a raw deal.

Managed accounts and special GP/LP arrangements are likely to become an increasingly common feature of the market, at least until the next large buyout boom breaks out. Certainly at the top end of the market, where Big Institution meets Big GP, the proposition looks compelling.

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