The Attraction of Investing in a Re-sized or Re-Positioned Fund with a New Story
The current market environment seems to be replete with examples of fund managers exceeding their fundraising goals with a “one and done” close and accomplishing these efforts in record speed – often less than 6 months in market. Many of these sponsors are top-quartile performers where their outperformance has enabled them to command excess LP demand. Others have developed a strong cult following among investors, often in no small part due to their strategic marketing and IR efforts between fundraises.
There is also a category of funds that have recently stumbled and are in the process of addressing fundamental issues, both internal and external. Typically, a first-time fund is reasonably sized, hyper-focused and able to deliver outsized returns. On the heels of this early success, some sponsors grow too quickly and raise much larger successor funds (Fund II), which take far longer to deploy and additional resources to execute. Invariably, as these outsized second funds continue to mature, the performance tends to suffer or shows troublesome inconsistency or volatility. This growth in fund size or deviation from strategy (across Funds) creates a dynamic where the sponsor is forced to rely on its original success rather than continued progression when coming back to market. Since LPs frequently look for the GP to continuously validate its strategy and ability to deliver results before re-upping into a successor vehicle, GPs who hit a “bump in the road” may find that future fundraises result in undersized or even stalled fundraises. How should LPs think about an established sponsor who may have stalled due to a bumpy track record, team turnover, a slower pace of investment or simply an unrealized historical portfolio? More importantly, how should you as the GP position yourself back to the LPs who may have decided to take a “wait and see” approach to your next fundraise?
In a recent conversation with several institutional LPs, it was clear to me that there is strong demand for what one of the LPs coined as the “Phoenix Rising.” The attraction stems from the notion that a high quality, high integrity and high performing manager doesn’t get stupid overnight. A sponsor with strong fundamentals, a talented investment team and superior DNA, which may have simply veered off course for one reason or another, can make a strong comeback and often times it is on the heels of this comeback that LPs can generate the best returns. By shedding the one weak partner, determining the key mistake made around the one portfolio-damaging transaction, identifying the breakdown in one’s investment process – and course correcting – a sponsor can perform at the highest levels it once did and all that made that manager attractive originally still remains. What separates the firms built for long-term success and those that disappear is that the most attractive GPs can clearly identify BOTH what went wrong and how they plan to fix it.
Many LPs today have developed a keen ability to recognize when a firm has renewed alignment and are pursuing their strategy with “something to prove.” They find comfort in this story. In fact, we’ve taken a look at the performance of a sampling of these transitional or bridge funds and have found that they frequently outperformed their peers in their respective vintages. There are even some LPs that have made investing into these vehicles part of their strategy. From the GP’s perspective, it’s an opportunity to hone in on what worked for them and they are increasingly motivated to access the carry dollars that they may have failed to recognize in their underperforming vehicle(s). Part of this transformation is a recommitment to a disciplined investment process; the GP frequently focuses on key elements like reconstituting the investment committee, recalculating carry or refocusing on the core sectors of expertise while being more proactive with management teams when transactions struggle.
The ability of sponsors to successfully rekindle their fund often hinges on their ability to communicate their transition with persuasion. It’s just as important to align the team around the new focus and management dynamic as it is to message this evolution to the LP market.
The key for GPs who have stumbled and are in process of becoming a phoenix rising is this: don’t let the message control you. Too often managers let past missteps define them or become the main focus of their story in LP meetings. If you are spending more than the first 5-10 minutes of a call or meeting presenting your history or course-correction – it’s too much. Learn to incorporate the lessons learned as more a part of the existing dynamic and take a forward-looking approach. Prospective LPs are looking toward your future, too. If you have a new portfolio, remember new LPs aren’t in the old fund so they just want to know you made the fixes and to hear about the new deals and what you’ll be doing for them in the new vehicle.
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Sixpoint Partners, LLC, is a registered broker/dealer, member FINRA (http://www.finra.org) and SIPC (http://www.sipc.org). Sixpoint Partners Asia Limited is licensed by the Securities and Futures Commission (http://www.sfc.hk).
