Offering multiple strategies: how to encourage LP engagement?
The offering of multiple strategies has grown in all asset classes as GPs seek to increase their market share. To name a few:
- in real estate, core is offered alongside core plus and value add;
- in debt, direct lending is offered alongside special opportunities and tactical credit; and
- in venture, later stage is offered alongside an incubator or growth fund.
However, GPs are not only focused on offering larger flagship strategies such as these but also niche dedicated strategies (e.g., in real estate: there might be a dedicated student accommodation and/or senior living fund or in debt: a dedicated venture debt or aviation financing fund).
This said, multiple strategy raising has its challenges:
If an LP is going to invest in multiple strategies with the same GP, it may prefer to do so through a bespoke managed account (thereby having a greater degree of control over strategy allocation and asset exposure) rather than through a series of blind pool funds.
There are investor relations and most favoured nation (MFN) considerations with offering fee discounts to LPs accessing multiple strategies. These are explored further below.
LPs are typically restrained as to how much they can allocate to a particular strategy and/or manager in a given year. Therefore, they may only have capacity to invest in one strategy at any given point. This can sometimes be addressed by holding closes either side of a new year so that the LP can put them in different yearly allocations.
LPs have limited internal resource and may not have the capacity to conduct due diligence on multiple strategies simultaneously. On a related point, if an LP has different investment teams covering different strategies, GPs may find themselves having to develop multiple relationships with the same LP.
Managing multiple strategies gives rise to questions on how investments will be allocated between them, how conflicts will be addressed and whether the GP has the resource to raise and invest more than one fund. GPs must get on the front foot and pre-empt LP concerns, by addressing these questions in their diligence materials, internal policies and procedures, and in the fund documents themselves.
To overcome these challenges, we are seeing GPs use the following:
The number one incentive used is a fee discount offered to LPs exposed to more than one strategy. This is typically structured as: (i) a flat discount across one or more products which increases based on the number of strategies and amount invested; and/or (ii) if a strategy has a tiered fee model, aggregating commitments across multiple strategies so an LP can access a higher tier in that specific strategy. In determining fees invested in different strategies, GPs usually permit investments from associates or the same investment advisor to be aggregated.
Offering fee discounts raises investor relations, legal and regulatory issues. LPs talk to each other, and word may get out about fee discounts. It is therefore important that a GP is comfortable with the fee discounts it offers, should information about those discounts become more widely known. If a GP offers differing fee discounts, it is important these are carved out of the MFN process, to avoid an LP with one discount electing a “better” discount. The MFN process under all strategies will need to be carefully drafted and policed by fund counsel. Finally, there are regulatory considerations and, in particular, the requirement under the EU Alternative Investment Fund Managers Directive to disclose the scenarios where the GP may not treat all LPs equally. This will likely require disclosure in the fund documentation that differing fee arrangements maybe offered to LPs investing in more than one of the GP's strategies.
As with fee discounts, GPs may offer prior access to co-investments to LPs who have exposure to more than one strategy. This is less common as GPs like to retain as much flexibility as possible over offering co-investment opportunities.
Although difficult to operate in practice (and typically only with evergreen fund structures), GPs are seeking to offer LPs liquidity and access to multiple strategies by permitting recycling between different strategies.
Offering streamlined reporting which has the same “look and feel”, including potentially reporting on the same strategies within the same report so it is easier for LPs to see their blended rate.
Ensuring that, aside from fees and strategy-specific items, legal terms are aligned across the different. This enables swift legal negotiation and a reduction in legal spend for both LP and GP.
Raising multiple strategies in this current environment is difficult. LPs are overstretched in terms of time, resource and available capital and GPs need to prove they can withstand a difficult fundraising environment and so are channelling efforts on less products to help achieve this. Fees are, and will in our opinion, continue to be the key driver for encouraging multiple strategy engagement.