A commitment to a private capital fund is the beginning of a long-term relationship. It requires strong conviction in the manager’s skills and considerable trust on behalf of investors. Detailed due diligence on the capability of the manager is critical. An evaluation of a fund should extend to an assessment of the fund’s commercial terms and the strength of the manager’s alignment with investor interests.
This paper outlines and provides discussion of a number of aspects of alignment and governance with respect to private capital funds.
Private capital funds in this paper are defined by their use of the closed-end fund model. This can encompass a range of different investment strategies and asset classes, including venture capital, private equity, private debt, distressed debt and some infrastructure and opportunistic property funds. Although there can be significant variation in investment strategies, the funds tend to be structured in a similar manner.
There are many non-financial factors which motivate investment professionals to work hard in order to generate strong returns for investors, including personal drive and commitment, market reputation and peer recognition. The qualitative assessment of investment professionals’ dedication to their fiduciary role, leaving aside financial compensation, is itself an important consideration.
Properly structured financial terms can create strong incentives for GPs to perform, but they are not perfect and circumstances can arise where effort and desire are diminished. Other events may occur, organizational or even personal, over the partnership term that can impair the GP’s performance.
Consideration of these aspects form part of Mercer’s manager research process, though they do not drive the process. A manager’s skill, competitive advantage and organizational stability remain paramount. We therefore do not encourage the appointment of inferior managers with superior terms, but instead aim to promote continued improvement in alignment and governance structures over time.