Re-Intermediating Investment Management

Abstract

A growing number of institutional investors are unhappy with the exposures they have to long-term alternative asset classes, such as private equity, infrastructure and real estate. This frustration has little to do with the underlying assets. Rather, it relates to the sub-optimal access points and governance structures that tend to intermediate institutional investors from the assets they are trying to invest in. Put simply, external fund managers enjoy a disproportionate amount of power relative to the value they actually add in these illiquid markets. This paper thus argues that investors may want to re-intermediate their investments in alternative asset classes and work with more aligned, external agents. Drawing upon contract theory, we propose a shift towards the relational contracting method based upon trust, mutual dependency, transparency and co-operation as a more aligned governance mechanism for the long-term. Such a method of governance can be achieved through bilateral arrangements such as co-investment agreements, funds-of-one, or managed accounts. In cases where pooled vehicles, such as the Limited Partnership ‘Fund’ model, are more appropriate (and relational contracting is difficult to implement), more emphasis should be placed on fee transparency and on negotiating robust termination clauses in order to incentivize managers and reduce the power asymmetry between the two parties. Structural barriers to the implementation of relational contracts for investment management are identified and relate to the ‘LP’, ‘GP’ legal short hands used in the industry, which consolidates the power of managers as well as the role of investment consultants as gatekeepers to investment managers.