Alignment of interest between manager and investor is often held up as a key selling point of the private equity model. Managers have their own capital at risk; if their investors do well, then they do too. If they lose investors’ money, they lose their own money with it.
Does this work in practice? Not all the time. The carry model can produce some perverse incentives to take risk in certain situations, while management fees can keep ailing firms in a state of zombification.
And as the chatter on the sidelines of a Geneva conference this week testified, general partners are becoming more confident about changing fund terms in their favour, whether it be lowered hurdle rates or a higher rate of carried interest.
But this is why you choose your partners carefully.
Some investors have realised that the way to iron out some of these alignment deficiencies is to grab a portion of the fees that they and their peers are paying to the GPs. As such there has been a mini-boom in funds being raised to take ownership stakes in general partners. Alaska Permanent Fund, the subject of our in-depth profile this week, is a major supporter of the two biggest such funds that have closed, committing $550 million to the $5.3 billion Dyal Capital Partners III and $500 million to the $3.3 billion Blackstone Strategic Capital Holdings.
But Alaska has made an even bigger play. It is understood to have revenue-sharing arrangements – a share of the GP’s management fees and carry – for both the Dyal and Blackstone funds. It has also made direct investments in a number of managers, including Whitehorse Liquidity Partners, Vista Equity Partners and EnCap, and launched a $700 million initiative with two other asset owners to provide cornerstone commitments to emerging managers in exchange for revenue-sharing agreements.
The sovereign wealth fund has aligned itself not only with the investment capabilities of its partners but also tied itself to the success of their franchises. It is by no means the first investor to do so; China Investment Corporation was one of the earliest, buying into Blackstone in 2007. You can read about the just-concluded relationship here.
As the asset class continues to grow in popularity, expect other investors to follow in these footsteps.