Investment management organizations can be categorized into
two types of entities: asset gatherers and performance
Performance shops are firms whose primary focus is
generating the best investment results they can. These
organizations tend to have a boutique, artisanal mentality and
dedicate significant resources to research, analysis, and
portfolio construction, often touting an edge
or at least a differentiated approach
in these processes. They try to make money by making money.
Asset gatherers, on the other hand, are those firms who
expend greater effort towards product development, marketing,
and distribution. These firms generally have great narratives,
particularly around benefits of scale, and many different
products offerings. These firms seem to make money by raising
The problem with such classifications is that binary
variables often mischaracterize realities which more accurately
resemble a spectrum. Its also often hard to distinguish
between the two in real time: Investment firms hire articulate
and aggressive salespeople, although no organization ever
admits they are going to skimp on the investment work because
its much easier to hustle down the next big allocator
One of the ways I think about determining where on this
spectrum an asset manager falls is by trying to measure the
resources deployed or the return on investment in
each of the two functions: sales versus performance generation.
While the philosophical contrast is present across
organizations throughout all asset classes, it is particularly
stark in alternatives, since the fee structure the
standard 2% and 20% creates a clearly definable revenue
stream for each.
First, if we ignore operations (and having started my career
in operations, trust me, most firms do), we can argue that the
organizational expenditure of effort on performance generation
must be equal to 100% minus the organizational effort towards
sales. We can try to proxy for this by looking at the size of
the sales or business develop teams relative to the total
employee count or assets under management, and compare that to
A more direct measure looks at the revenue an investment
manager receives from fixed asset-based fees versus the revenue
to the general partner from variable incentive fees a
perfectly clean breakdown of the returns to gathering assets as
opposed to generating investment performance.
A good example of this is the analysis we recently completed
for a potential fund II investment with a small buy-out
manager. Their fund I, roughly five years old, has generated
approximately $30 million in management fees, and $53 million
of accrued carry with nearly 25 full time employees.
This firm may not be struggling, but at $6 million a year to
pay for 25 people, benefits, systems, office space in New York,
and more, they are not getting fat off the management fees.
They are betting on the carry.
On the other hand, a very large and well-established private
equity shop is coming to market with a $20 billion fund target,
which they will almost assuredly hit. They have strong
historical returns, are very institutional, and demand for
large funds is robust. In 2016, according to data from Preqin,
nearly 900 private equity funds closed, raising a combined $350
billion with a disproportionate amount of that going to
larger funds. Nearly 40 percent of the private equity capital
raised last year went to the 20 largest funds, and 26 percent
went to just the top 10.
So what will this manager earn from management fees as
opposed to carry?
Well, with a 1.5% fee on committed capital, this manager is
locking in $300 million a year for five years a
guaranteed revenue stream of $1.5 billion just for raising the
fund. In this case, they are getting rich off the management
fee, and if everything works out well super rich
off the carry.
There is certainly a role to play for platform providers,
but we should question ourselves: Is originating and
underwriting four to six private deals each year even at
scale, even with 100 investment professionals worth $300
million a year in contractually guaranteed revenue? Or is that
just getting rich by raising money, instead of by making
Christopher M. Schelling is the Director of Private
Equity at the Texas Municipal Retirement System.