The appeal of the separate account

There are many reasons why investors choose to set up separate accounts; performance may not be one of them.

Separately managed accounts present investors with several advantages. They can help reduce fees and the number of GP relationships, while increasing transparency into costs and investments.

“SMAs provide this unique capability to capitalise on investment strategies that you’re not going to get access to through typical private equity funds, venture capital funds, secondaries funds and things along these lines,” says one limited partner with a mature private equity programme and several separate accounts. “They give us the ability to control the timing of the investment and more control over our portfolio: that’s really the key to us.”

With all these positives, it’s no surprise that LPs are moving in this direction.

SMAs represented 6 percent of private capital raised last year, up from 2.5 percent 10 years ago, according to Bain & Company’s most recent global private equity report.

KKR was nearing a close on a $3 billion separately managed account with New York City’s five retirement pension plans to invest in private debt, private equity, real estate and infrastructure, Bloomberg reported in August, though the firm declined to comment. And earlier this week, stories surfaced that one of the options being discussed for California Public Employees’ Retirement System’s $26.2 billion private equity programme is for its management to be “outsourced” to BlackRock. CalPERS confirmed the discussions, adding that no decisions have been made and that it is still looking at alternative models to bring to the board. This – if it came to pass – would be the mother of all separate accounts.

At the smaller end of the spectrum, LPs from South Korea’s Public Officials Benefit Association to San Bernardino County Employees’ Retirement Association have recently signed new separate account deals.

So what else is drawing investors to SMAs apart from fee breaks and administrative streamlining? It doesn’t appear to be performance – aggregated performance data for separate accounts is difficult to come by and the small amount of publicly available data is inconclusive.

For example, New Mexico Educational Retirement Board has so far secured a higher return with its two $100 million SMAs with BlackRock than it would have if it picked a similar vintage BlackRock commingled fund, while CalPERS’ $800 million commitment to Apollo Special Opportunities Managed Account from 2007 returned a lower net IRR than if it had committed to Apollo Investment Fund VII of the same vintage.

“The performance differential [between SMAs and commingled funds] isn’t as large as one would expect from a theoretical perspective: the returns are on par with what the buyout funds have been giving us,” the same LP says.

So the draw for investors is likely to be flexibility when economic conditions change. The ability for an LP to shift allocation between asset classes and strategies within the same programme could prove valuable during times of dislocation within private capital markets.

As the LP says: “We think over time the flexibility of those accounts is going to allow us to outperform the passive fund investments.”

And GPs benefit from SMAs, which allow them to forge a stronger relationship with LPs, have access to more stable revenue and to allocate across a platform of investments. The reasons to use SMAs just keep adding up – and the total capital committed to them is likely to be the same.