Flat Stan

Imagine receiving a letter from your GP that delivered the following items of information:

•Your GP is stressed at seeing his funds grow so large and worried that the burden of managing such large vehicles is negatively affecting performance;

•Your GP is personally disappointed in his returns, even though returns have been positive through the market downturn and even though his investors say they are satisfied with recent performance;

•The GP therefore intends to retire from fund management.

Hard to imagine? In the realm of private equity, such a letter does not to my knowledge exist. There may be something in the very DNA of buyout funds and their founders that prevents such a letter from being written. A missive this candid and self-deprecating is also rare in the hedge fund world, and yet this is exactly what hedge fund legend Stanley Druckenmiller recently communicated to his investors.

David Snow

Last month, the founder of Duquesne Capital Management, a Soros spin-out, informed his investors that he would be retiring from managing client funds. The reasons detailed add up to “It’s not you, it’s me”. Druckenmiller wrote: “You may remember that I chose to leave Soros Fund Management ten years ago because the challenge of managing an enormous amount of capital was having a clear impact on my ability to perform. . . Unfortunately, as Duquesne has grown, these factors have again emerged.”

Although his clients were satisfied with the hedge fund’s performance through the turbulence of 2008 and 2009 he wrote “I was dissatisfied with those results because they did not match my own, internal long-term standard”.

If any reader is aware of a buyout kingpin who has departed in a similar fashion, please let me know. In general, however, it would be very hard to find a private equity founder willing to admit that, one, the growth of his fund sizes have negatively affected performance; two, he feels personally responsible for the weak performance; and, three, he is retiring with immediate effect.

Druckenmiller is certainly not the only high-profile hedge fund manager to shut down operations in recent years. Because they normally invest in liquid assets and allow their investors regular redemptions, it could be that the very structure of most hedge funds forces their managers toward instant and extreme self-assessment. A fund manager that might be put out of business in a single quarter will tend to genuflect more deeply before investors.

Not so for private equity funds, with their 10-year lockups and imprecise interim valuations. The long-term nature of private equity allows managers to use placeholder language while they hope for reversals of fortune. A GP who is despised by his LPs today knows that in five years, half of the LPs may have new jobs elsewhere and in the meantime the fund’s performance may have improved.

GPs in private equity are more likely to blame unforeseen market forces for tepid performance than to blame personal missteps. To admit, for example, that lust for giant funds led the firm into an unfamiliar and difficult new deal environment would essentially be an admission of a near fatal error in judgment.

One doesn’t often hear the term “retirement” in private equity, at least not in the US. While a number of big-time hedge fund managers have announced their retirements in recent years, it is hard to think of any private equity founders who have simply walked away from the job. More often, these founders hold forth the promise of long (or excruciatingly long) succession plans, or, in too many cases, have no succession plans, somehow believing their investors will have no opinion about committing capital to a ten-year fund under the iron rule of a septuagenarian.

Missing from Druckenmiller’s letter is any guidance as to whether Duquesne will continue to be managed by a next generation of managers. It will not. The key and irreplaceable asset of Duquesne is Druckenmiller himself. This is another key distinction between hedge funds and their illiquid cousins in private equity. Most private equity GPs argue that their success can be duplicated by their younger partners, although clearly not all of them believe this. If private equity shop founders believe their firms will underperform sans the founders, they should let LPs know as soon as possible. No succession plan ever worked where the founder believed himself or herself to be irreplaceable.