BLOG: Customised Accounts – Making Private Equity Bespoke

Over the past decade, many investors have sought to invest in private markets in a more targeted, efficient and flexible way. To do so, they have increasingly turned to customised accounts (or segregated managed accounts), which provide bespoke access to private markets investments outside of the traditional commingled limited partnerships. Here, nearly every aspect—from fee structures to regional and sectoral exposures—can be specially tailored to the individual client.

This trend speaks to a maturing of the private equity industry, following the proliferation of funds covering a range of strategies and regions during the past decades, and the evolution of the fund-of-funds as a simple way to potentially navigate that diversity. Today, many investors are looking for the fee efficiency, transparency and control that custom accounts may offer. Investors with less than $100m to commit may find the set-up and maintenance costs uneconomical—but for many others, it can be a viable and attractive option.

So, what are some of the key advantages?

CONTROL

Custom accounts can reflect investors’ preferences in nearly every area, from asset class, region, currency, industry sector or investment strategy, through methods of implementation (such as primary fund investments, secondaries, direct investments), to other portfolio preferences and restrictions, including sustainability criteria.

With a custom account, investors can determine the pacing of capital deployment, and accelerate, suspend or alter it in response to changes in market conditions or their own circumstances. In the event of a market dislocation, capital can more quickly be redirected toward secondary investments, distressed credit or special-situation investments in a way it likely could not if it had been committed to a commingled fund, for example.

Investors may want to be involved in the planning, construction, due diligence, selection and monitoring of their portfolios to varying degrees. Investors with limited staff resources, or those operating under regulatory constraints, may get involved in “big picture” decisions such as portfolio planning and guidelines-setting, while delegating due diligence, selection and monitoring to their custom-account manager. Others may wish to participate in due diligence and selection, through veto rights or joint investment decision-making with their manager; this gives those investors more influence over portfolio construction, and a deeper understanding and knowledge sharing.

FLEXIBILITY

Customised accounts frequently afford investors the flexibility to construct portfolios in different ways. Those investors new to private markets may simply look to build a balanced, well-diversified program with their custom account manager. Existing private markets investors may use custom accounts to pursue complementary programs, filling gaps in their portfolios or fixing portfolios that have become disjointed or unbalanced. A small in-house private markets team may outsource the entire program. A larger team may want to concentrate their own efforts where they have direct access and knowledge, while outsourcing to an external manager portions of the portfolio involving strategies or regions where they lack expertise or resources.

KNOWLEDGE TRANSFER

Custom account investors and their private equity managers can become genuine partners. Custom account investors often endeavour to draw on their manager’s expertise to gain broader and deeper insights into the market, to monitor their legacy investments, to supplement their due diligence efforts on investment opportunities outside the account, among other aspects.

This may facilitate substantial knowledge sharing that the client can use to enhance its own activities and eventually even bring further elements of the program implementation in-house. For the manager, it adds a layer of operational complexity given the extended client service aspects it entails. This more engaged approach to a customised program partnership could involve the manager becoming almost an extension of the client’s investment team.

COST EFFICIENCY

Implementing and maintaining a custom account sounds expensive; for many smaller investors investing through a standard commingled vehicle remains a more viable path. However, above a break-even size threshold, a custom account can reduce rather than increase costs for the client—particularly relative to the costs of running a program in-house, but also relative to a commingled fund.

Traditional commingled funds allow limited negotiation over terms: fee charges are commonly prescriptive and applicable to all investors, in some cases with differences depending on the size and timing of an investor’s commitment.

By contrast, fee charges are another element that often are customised on a custom account, including the fee composition (such as the split between management and performance fees), the basis for fee assessment (such as whether management fees are assessed on capital committed, capital invested, or net asset value), the fee rates, timing of such charges, performance hurdles and other aspects.

The reason investors with smaller commitments may find custom accounts uneconomical are the fixed costs of setting up and maintaining them. Commingled funds often share the cost of legal set up, administration, audit, tax filings, regulatory compliance and registrations among several investors, whereas typically a custom account investor bears solely the entire burden. Where the size of the account justifies these fixed costs, however, the overall cost benefit can be significant.

INSOURCING VERSUS OUTSOURCING: PEOPLE, ACCESS, KNOWLEDGE (“P.A.K.”)

If the point of a custom account is to exert more control and bring down costs, why not go it alone completely?

We believe that is a challenge even for the very largest institutional investors. A partnership with an established manager frequently brings three key elements to the task: “People, Access and Knowledge”. These are crucial not only to ultimate success, but also to timeliness, of the program implementation.

People and their experience are central to private markets investing. Even when an investor has sufficient budget to build an in-house team, it can be difficult to find experienced local talent. Moreover, many investors seek to mitigate the “j-curve” of private markets investments by integrating secondaries and co-investments into their programs, which demands a whole new layer of expertise, skills and relationships in addition to those required for standard manager due diligence.

Access to high quality, oversubscribed funds is often limited, which makes established relationships with general partners very valuable.

Knowledge held in extensive databases of prior investments, manager and individual track records can lend a critical edge in an industry where information is rarely publicly available.

This is why we believe many investors choose to establish a customised account in partnership with an external manager. When done well and with the right partner, it allows investors to “plug and play” with an experienced team that acts as an extension of their own staff.

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