By Bill Kelly, CEO, CAIA Association
Why are we still talking about this? No, it’s not the central bankers and their insatiable easing tendencies, trade wars with China, or even the Women’s World Cup football match (sorry Netherlands!). These stories all make great headlines, drive news ratings, generate tickertape parades, and, in some cases, push equity indices to new highs, seemingly every single week. While less sensational perhaps, it is the ongoing lack of transparency between GP and LP that we ponder here today.
According to Institutional Investor, there currently are a record-setting 4,000 funds actively looking to raise $1 trillion of fresh capital from the return-seeking LPs. That’s a big number and is incremental to the $1.5 trillion of previously raised funds already sitting on the sidelines. All of this capital is now waiting to be invested, at a time when risk assets have been largely bid up to levels that are sure to bring greater performance dispersion across the PE industry, along with average returns that will provide little to no premium over the public market proxies. One can only wonder on what page in the pitch deck you can find that disclosure. And, all of this comes at a time when the highly criticized use of credit lines to fund capital commitments is still in the news and is now being positioned as a good strategic option by at least one GP.
Consider this too…the fuel for the expected outsized returns have come (to a large degree) via the deployment of leverage at a time when capital is almost being given away. This too shall change despite the current weak-kneed posture of the central bankers around the world. If you don’t see that coming, rest assured that the GP community does and that has given you new and fun-sounding defined terms such as trap doors, black holes, and restricted payment baskets. Never heard of them? Check your offering memorandum. We are in the cov-lite hour of the market and when the tide goes out these terms will define who gets what and the LPs should be preparing for that inevitable storm. The FT also hammered this point home in a recent article about the doc-lite situation in the $1.2 trillion leveraged loan market. They cite some Moody’s data that shows less than a third of the new deals contain a provision for regular calls with management, and extra time is being routinely granted to update their creditors (the LPs) with essential financial information. Does it really take 120 days (or more) post-quarter end to calculate an interest coverage ratio?
Interesting that we now turn to the oft-criticized hedge fund space to get some clarity around a commitment to transparency. Our friends at AIMA, in conjunction with RSM, just published an interesting research piece entitled In Harmony where they explore the alignment of interests between the managers and the allocators. Their research encompassed GPs who run more than $400 billion in hedge funds (about 15% of the global pie) along with input from global investors responsible for allocating over $1 trillion, including double-digit commitments to hedge funds. This report is timely, topical, and seeks to (un)cover all aspects of the underlying business model with a primary emphasis on what they call the three Cs: customization, collaboration and communication. They describe an industry, led by the GP community, that is moving from asset-gathering hunters to long-term relationship builders, as the broader commingled offerings are yielding more to a solutions-based fund of one, mostly because that is what the client wants.
It is often the hour between dog and wolf when you don’t really know if that is now a barbarian or an aligned partner at your gate. Retreat, or hoping for the best, does not come with much optionality. This time it is the hedge fund that has (be)spoken. Harken that call for greater transparency and make it core to your investment policy statement.
Seek diversification, education, and know your risk tolerance. Investing is for the long term.