One of the most important questions an institutional investor asks when deciding whether to invest with a particular fund manager is, “Can I trust them to manage this money?” The problem, of course, is that there isn’t always an easy way to determine the answer.
An investor needs to know if a GP will act as a fiduciary, putting the needs of the LPs ahead of personal gain. This is especially important when a deal gets into trouble because that is when interests can diverge. Investors need GPs with strong moral codes, who will do what is right, not what is expedient.
But “character” is an amorphous quality, not easily quantified or measured. This is why institutional investors have settled on certain key elements as “proxies” for measuring character.
One of these measures is co-investment. The belief is that, if GPs are putting their own personal wealth at stake, it will align their interests with that of the GPs. An active discussion is going on at IREI’s LinkedIn discussion group about the importance of co-investment.
Another measure is track record. A GP’s history is important not just to see if the manager has outperformed over time. Investors should also pay attention to how GPs have handled dicey situations, and if they were honest and aboveboard in their dealings with LPs. But an emphasis on track record may cause LPs to ignore emerging managers, who have not yet had the time to develop a history.
Transparency is also important. LPs care about communication and openness because it can be a mark of good character. A manager without secrets has nothing to hide. But, as with co-investment or track record, transparency itself is no guarantee that a manager will behave with diligence, prudence, fiduciary responsibility and good character.
All of these measures can only point toward the real question: “Can you be trusted?”
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Loretta Clodfelter is a contributor to Institutional Real Estate, Inc.
