When Private Equity GPs Play Favorites | Chief Investment Officer

Blackstone had more capital rolling in via separate accounts and custom vehicles than its massive commingled funds as of early 2015, COO Tony James said in an earnings call.

“We’re much more in the business of creating special vehicles for LPs [limited partners] that want certain things,” James told listeners. Those “things” could include shortened redemption periods, lower management fees, greater transparency, co-investments, and access to assets that don’t fit within a typical commingled structure.

Private equity firms across the board have been seeing—and meeting—rapidly rising institutional appetite for special arrangements, Preqin data have shown.

But doesn’t mean commingled fund investors are getting a raw deal, according to an in-depth analysis by Yale Law School’s William Clayton.

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Why give a top-notch opportunity to LPs paying discounted fees, for example, unless it’s unworkable in the main fund?“Most forms of preferential treatment enabled by individualized investing create new value for the preferred investors who receive the favored treatment, rather than appropriating that value from non-preferred investors,” Clayton found.

Most value-additive perks of separate-account investing wouldn’t be reaped at all if these structures ceased to exist, he argued. Why give a top-notch opportunity to LPs paying discounted fees, for example, unless it’s unworkable in the main fund?

That high-conviction deal also would also contribute to a firm’s track record in a commingled fund, Clayton noted, but has little fundraising upside in a side vehicle.

“The value of pooled-fund track record thus serves as a strong source of protection for pooled-fund investors,” he added—possibly to the extent of favoring them over separate accounts.

LPs’ desire for some control over allocation decisions has been another major driver in the custom-vehicle boom, Clayton wrote. Commingled fund investors have essentially none, beyond their initial allocation choice. Co-investments empower LPs in way that’s impossible if they’re one of dozens or hundreds of institutions, where reaching consensus would be impossible in practice.

While the trend of customized private-equity vehicles doesn’t meaningfully conflict with commingled investors, Clayton argued, it’s hurting asset owners as a whole in one major way.

“An interesting side effect arises out of the growth in individualized investing: The fact that the incentive for broad coordinated action among private equity investors weakens as investors’ interests become more individualized,” the author found.

When many of the most powerful asset owners have negotiated acceptable fees and transparency via special arrangements with private equity firms, the fight for fair universal standards may be left up to those least able to win it.

Read William Clayton’s research paper, “In Praise of Preferential Treatment in Private Equity,” published March 16.

The University of California’s (UC) Board of Regents has approved a new retirement plan that would shift the organization’s $95.7 billion fund away from the defined benefit (DB) model.

The new program—set to affect employees hired on or after July 1, 2016—offers two choices: a combined defined contribution (DC) and DB plan or a straight 401(k).

UC President Janet Napolitano, who presented the plan at the board’s finance meeting last week, said it would save the system $99 million annually on average over the next 15 years—as well as speeding up funding for pension liabilities.

“These changes are reflective of the hard choices we need to make to ensure the university’s long-term sustainability and to sustain its academic excellence,” she said.

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The UC committed to reforming its pension plan as part of a 2015 budget agreement with the state governor, which granted the university an additional $1 billion, including $436 million over three years to pay off unfunded pension liabilities.

In exchange, the Regents agreed to cap salary eligiblity for defined pension benefits at $117,020, with a 401(k) supplement for employee pay above that amount.

Employees will also have the choice to opt out of the DB plan altogether in favor of a pure DC plan. These participants will receive a higher employer contribution—8%—while the hybrid plan matches 3% to 5%.

Currently, the defined benefit pension is the largest of the university’s five capital pools, with its $53.6 billion making up more than half of total assets.

The defined contribution plan totaled $19.6 billion as of December 31, 2015.