An investor looking for exposure to alternative assets generally invests in alternative investment funds and may also co-invest in the funds’ portfolio companies. But a third option has hove into the public spotlight in the last decade: investing in the fund managers themselves. This is a relatively new and fast-growing part of the asset class known as GP stakes investing, and it is the subject of this article, which is the first in a two-part series.
A GP stakes investment is the direct acquisition of a minority equity position in an alternative asset manager (GP); in other words, making an investment in the fund sponsor as opposed to in (or alongside) the fund itself. The strategy represents a bet on the future growth and profitability of the investment firm behind the fund. It has grown more popular in recent years because it gives the investor a share of returns from what may be multiple funds and accounts managed by the firm – and, thus, the advantage of diversification – rather than just the income and gains from one of those funds.
They are usually structured as the direct acquisition or issuance of anything from one-tenth to one-third of the management firm’s shares. Typically, these minority stakes are passive, non-strategic and non-voting. Given that asset managers are essentially ‘people businesses’, reliant on fairly mobile human capital, preserving the firm’s culture and compensation dynamics is often recognised as crucial to its long-term sustainability. By limiting outside investment to a minority stake, the GP’s senior executives are able to maintain decision-making autonomy without disrupting the team or culture, while at the same time benefiting from a partnership with the outside investor that adds value both to its balance sheet and its business plan.
Investors are always keen to invest more efficiently and reduce the proportion of their investment capital that is swallowed by fees; the option to invest at the GP level and gain positive exposure to fee flows and carry is clearly attractive. Co-investing alongside a GP can reduce fees, but investing in the GP, itself, can reverse the flow.
Early GP stakes investments were targeted at hedge fund managers, but in recent years the focus has shifted heavily toward closed-ended and long-term investment structures, which benefit from yield certainty thanks to regular management fees and accrued (but as yet unrealised) carry.
On the buy side, although a number of new players have risen through the ranks of traditional PE investors, the market continues to be dominated by three major investors: Blackstone Strategic Capital Partners, Neuberger Berman’s Dyal Capital Partners, and Goldman Sachs’ Petershill unit. According to a recent Pitchbook report, each of them has raised funds in excess of US$4 billion dedicated almost exclusively to this strategy. At the end of 2019, Dyal ramped up the stakes by closing its fourth fund with more than US$9 billion in capital, making it the largest GP stakes fund ever raised.
On the sell side, GP stakes investments were traditionally confined to managers with proven track records. Recent recipients of an external equity cash injection include Accel-KKR, Kohlberg & Co., Clearlake Capital Group and Bridgepoint Advisers. Nonetheless, the ever growing pool of capital available to GP stakes investing specialists is itself widening the pool of candidates.
The primary and most obvious benefit to an asset manager of selling a minority stake is the injection of liquidity into the business. This helps the manager to:
Even though it’s only a minority shareholder, a GP stakes investor can also add strategic value:
Taking a position in an asset manager is unique in that it offers returns from various avenues:
On the strategic side, GP stakes investors benefit from:
When GPs are able to raise successor funds, the average size of the fund tends to increase, which itself boosts the income streams – fees, carry, etc. that GP stakes investors have bought into.
Investing in this asset class seems like a win-win. But as with anything, one has to be careful. In Part 2 of our series on this topic, we will examine some of the risks of taking a piece higher up the asset manager food chain and how to best mitigate them.
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