separate accounts in private equity custom solutions...

SEPARATE ACCOUNTS IN PRIVATE EQUITY

Custom Solutions, Targeted Investing

MAY 2017

HARBOURVEST SEPARATE ACCOUNTS IN PRIVATE EQUITY | page 1

CONTENTS

INTRODUCTION ___________________________2

FOUNDATIONAL COMPONENTS OF AN SMA _______3

HOW PRIVATE EQUITY INVESTORS USE SMAs _____4

CASE STUDY: TRANSITIONING FROM A FUND OF FUNDS ________5

DETERMINING IF A CUSTOM SOLUTION IS RIGHT FOR YOU ___________________________6

TOP-5 MYTHS ____________________________7

I’M READY TO START AN SMA… NOW WHAT? _____________________________8

SUMMARY _______________________________9


Today’s low interest-rate environment is prompting more investors to look outside the box for new alpha generators – and private equity, with its strong historical performance relative to public markets – is garnering increased attention. As investors give the asset class a closer look, their first big decision revolves around whether to utilize a separately managed account (SMA) or a commingled fund to access the world’s private markets.

Commingled funds have been the dominant private equity vehicle since the industry first took flight back in the early 1980s. This involves investing in a blind pool with other investors, with the manager assuming all of the associated portfolio duties, including sourcing, due diligence, and accounting.

More recently, though, SMAs have become popular due to their flexibility and precision, as well as the opportunity they provide to work more collaboratively with an external investment partner. Investors tend to choose SMAs for several key reasons, including the ability to:

>> Target specific types of managers to fill a portfolio gap (e.g., venture capital managers in Asia, or those focused on middle-market opportunities)

>> Build and manage a custom solution that is aligned with their specific time horizon and funding obligations

>> Work with an experienced external partner to acquire market knowledge and investment skills through on-site training

>> Complement and further diversify an existing portfolio of assets

>> Ensure proper oversight and operational support on an ongoing basis through the more service-intensive SMA model

>> CHART 1: COMPARING ACCESS VEHICLES

SOLUTION SMA COMMINGLED FUND

Typical Size $100 million to $1 billion+ $1 million to $300 million+

Investment Objectives Flexible; determined by the investor Defined; determined by the manager

Services Core plus additional customized services:>> Legacy portfolio monitoring>> Cash flow projections>> Knowledge/transfer training>> Staff extension

Defined, core services:>> Investment selection and oversight>> Consolidated reporting and cash flow management >> Some customization through side letters

Structure Bespoke jurisdictions and format Delaware / Cayman / Scottish / Luxembourg

Expenses Typically bear all costs directly Share costs across all investors

Construction Customized through strategic and annual planning Set / standardized

INTRODUCTION


FOUNDATIONAL COMPONENTS OF AN SMA

SMAs are becoming more prevalent in part because they provide an advanced degree of flexibility around the three core components of a PE investment program: the investment portfolio, value-added services, and the format and jurisdiction of the actual vehicle. Depending on your specific profile and objectives, SMAs allow you to lever up or down the ingredients that go into each of these buckets (see Chart 2).

In terms of the investment portfolio, for example, investors can work within the boundaries of an SMA to address specific needs by creating an optimal mix of investment types, geographies, and strategies.1 SMAs also allow for flexible commitment periods, as investors can opt for shorter or multi-year arrangements with their providers.

Additionally, SMAs allow investors to tailor the level of service they receive to support essential functions such as reporting, portfolio analytics, cash management, and risk controls.

Last, structural considerations are also critical – and issues such as tax treatment, transparency, the burden of administration, regulatory sensitivities, and jurisdiction are all key factors in finding your optimal structure. Separate account structures may include a dedicated “fund of one” or an investment management agreement. If a “fund of one” is preferred, further structuring discussions will inform the choice of entity and jurisdiction for the fund vehicle. Whichever structure you choose, it is vitally important to entrust your program with a team that has deep structuring expertise.

1 To learn more about building an appropriately diversified portfolio, see HarbourVest’s Viewpoint, Private Equity Portfolio Construction: A Four-Step Guide to Getting Started, October 2016.

>> CHART 2: CUSTOMIZATION COMPONENTS

FORMAT & JURISDICTION

VALUE-ADDED SERVICES

Consolidated Reporting

Cash Management

Investment Monitoring

Portfolio Analytics

Tax Oversight

Fiduciary Responsibility

GP Introductions

Due Diligence Support

Knowledge Transfer

INVESTMENT PORTFOLIO

TYPE GEOGRAPHY STRATEGYCOMMITMENT

PERIOD

Primary US Buyout 1 Year

Europe Venture

Secondary 2 YearsAsia Growth

Direct Co-invest

Emerging Markets

Credit

3+ Years

Real Assets

Partnership Corporation Unit Trust IMA

Delaware Cayman Scottish / Luxembourg Other


Investors tend to approach SMAs from four different perspectives based on their specific needs, constraints, and objectives. Each “model” varies depending on how much you want to participate in the investment and decision-making process, as well as the level and extent of services you require.

HOW PRIVATE EQUITY INVESTORS USE SMAs

Turnkey (full service)Helps new investors create customized portfolios, gain knowledge, and address specific service needs. Client generally cedes investment decisions to the manager.

Transition from Fund of Funds (FoF) to an SMA Allows existing investors to be more engaged and increase control. Investment decision-making is shared.

Services FocusedNew or existing investors

may want to fill in a particular skill or

service gap; the client typically retains investment

decision authority.

Portfolio CompletionExperienced investors can use

SMAs to target niche strategies or regions. Both the client and manager

can make investment decisions.

CASE STUDY: TRANSITIONING FROM A FUND OF FUNDS

If you are already investing in private equity through a commingled fund and are testing the SMA waters, consider the case of a large, US-based private pension plan that worked with us to make the transition. The client wanted to shift from a FoF to a 10-year, $750 million SMA in order to consolidate managers, gain more control over investment pacing, and put capital to work quickly and efficiently. As an experienced investor with a thin staff, the client also wanted a high-touch relationship that would provide investment transparency and pacing strategy.

Working collaboratively with the client, we took the following steps to build a more concentrated portfolio of primary investments in buyout, venture, and special situation funds, complemented by investments in secondaries and co-investments.

RESULT

With the pivot to the SMA, the plan was able to consolidate its portfolio of over 300 managers down to 20, gain more control over investment pacing, and achieve accelerated access to key investment opportunities.

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Developed long-term strategic and annual tactical plans to help assess managers globally

2

Created customized investment guide-lines and instituted controls to safe-guard from risks

3

Leveraged our global investment platform to pare back the number of managers and provide faster access to secondary and co-investment opportunities



The process around deciding which access vehicle to utilize will be different for every investor. With SMAs, as with any investment, you should do your research on how they work, ask questions, study different allocation approaches, and overlay what you learn with your desired objectives. Of course, having worked with investors for more than 30 years on this decision, we realize that this is easier said than done. So we decided to survey our resident experts, and compiled the following key questions and myths to help you make a wise, informed choice.

Are you new to the asset class or do you have an existing PE portfolio?

If you are a new PE investor, you may simply wish to start out by gaining exposure to the private markets through a broadly diversified portfolio. If this is the case, a commingled fund is likely the more straightforward, cost-effective choice. If you have existing PE assets, your current allocation mix across strategies and geographies will help identify any gaps you may have, which can be filled effectively with an SMA.

What are your short- and long-term objectives?

Defining what near-term and future success looks like for you will also help guide your access decision. If your objectives are broad in scope, commingled funds may be the best option. If your objectives are more specific and targeted – such as acquiring new investment skills or deploying capital more quickly – SMAs are an appropriate choice.

What are your investing strengths and weaknesses?

Before you implement a separate account, it’s important to candidly evaluate your strengths and weaknesses to better gauge your ability to execute on your private equity program. If you are a new investor, your organization may lack the specialized investment expertise necessary to source and assess managers globally, and you may not have the resources needed to administer and monitor deals. SMAs address both issues by providing knowledge-sharing opportunities and extensive monitoring and service capabilities.

Given the challenges inherent in private equity investing, is an SMA the best approach for you?

Defining your objectives and identifying strengths and weaknesses will go a long way toward determining if an SMA is the best option. It is particularly important to be aware of the complexity and resource-intensiveness of private equity investing in general, as well as the level of engagement SMAs demand. For example, if you use an SMA to access co-investment deals in Europe with an eye toward gaining due diligence expertise for your staff, your level of engagement will be dramatically higher than if you were investing through a commingled fund.

DETERMINING IF A CUSTOM SOLUTION IS RIGHT FOR YOU


TOP-5 MYTHS

As separate accounts have gained traction in recent years, several perceptions have taken hold that warrant closer examination.

Investors cannot strategically adjust their portfolio allocation once the SMA has begun to make investments

To the contrary, SMAs offer the ability to make tactical changes on the fly. A responsive SMA provider will ensure that your solution is set up to provide maximum latitude for adjustments.

An SMA investor can execute specific strategies on their own within a separate account

Not true. Executing strategies on your own within an SMA can make it difficult, if not impossible, to adhere to the investment guidelines and restrictions that have been established to help guide your program.

SMA investors cannot access commingled funds through separate accounts

Actually, investors can access commingled funds through separate accounts if they so desire. These vehicles are simply another means for deploying capital across the portfolio.

SMAs are the lowest cost private markets solution available

As the SMA “menu” of capabilities and services tends to be more a la carte in nature, you truly do get what you pay for. If you choose to utilize an SMA to access secondary investments, for example, which typically require more extensive due diligence because of their complexity, the execution costs will likely be higher than with a commingled fund.

If your goal is to put capital to work quickly and lower your economics, it would be better to make direct investments on your own than to enter into an SMA

The significant upfront, ongoing investments required to identify, evaluate, and negotiate with managers globally – as well as to provide continuous oversight – makes it likely that only a few large investors will have the resources and expertise needed to quickly and cost-effectively make investments on their own.

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If you choose to go down the SMA route with an external manager, we recommend the following three-stage planning framework as you start to build a custom solution that is aligned with your needs.

I’M READY TO START AN SMA… NOW WHAT?

Strategic Assessment

Implementation

Oversight

>> The strategic assessment exercise includes reviewing any legacy portfolio assets you may have, assessing your overall risk sensitivity, and studying any prevailing macro trends. At this stage, you should also set strategic allocations, formalize investment guidelines, and identify your reporting needs.

>> In the implementation phase, the focus will be on reviewing annual tactical plans, selecting managers, and reviewing your deal-flow pipeline.

>> The final phase revolves around ongoing oversight of your portfolio, which is critical in determining where refinements should be made. Here, you will work closely with your manager on several key tasks, including program reviews, portfolio analysis, performance monitoring, benchmarking, and risk management.


SUMMARY

Hopefully we’ve given you some useful food for thought as you contemplate which approach or model would work best for you. If you’ll pardon the trite health care analogy, accessing the markets through a fund is like going to a general practitioner, while utilizing an SMA is akin to visiting a specialist. In the same vein, both commingled funds and SMAs have an important place and purpose in today’s private equity landscape.

Ultimately, your success will turn on choosing a model that suits your objectives and resources, as well as selecting an experienced, reliable partner to help execute your strategy. At the top of your partner shopping list should be managers that have a reputation for being client-centric; are highly collaborative and flexible; offer a clear, transparent governance and operating structure; and have a global platform that provides access to high-quality investment opportunities and relationships.

We have learned many lessons from working with all types of investors over the last three decades. One common observation: the more work and thought you put into front-end planning, the better your chances of success down the road.

Ultimately, the partner you choose to work with should be experienced, service-oriented, collaborative, and committed to being flexible and innovative in finding the right solution for your needs.

Beijing | Bogotá | Boston | Hong Kong | London | Seoul | Tel Aviv | Tokyo | Torontowww.harbourvest.com

HarbourVest is an independent, global private markets investment specialist with more than 30 years of experience and more than $40 billion in assets under management. The Firm’s powerful global platform offers clients investment opportunities through primary fund investments, secondary investments, and direct co-investments in commingled funds or separately managed accounts. HarbourVest has more than 400 employees, including more than 100 investment professionals across Asia, Europe, and the Americas. This global team has committed more than $31 billion to newly-formed funds, completed over $15 billion in secondary purchases, and invested over $6 billion directly in operating companies. Partnering with HarbourVest, clients have access to customized solutions, longstanding relationships, actionable insights, and proven results.

This material does not constitute an offer or solicitation for any fund sponsored by HarbourVest Partners, LLC (“HarbourVest”) or its affiliates, or any investment services provided by HarbourVest. No sale will be made in any jurisdiction in which the offer, solicitation, or sale is not authorized or to any person to whom it is unlawful to make the offer, solicitation or sale.

This document includes information obtained from published and non-published sources that HarbourVest believes to be reliable. Such information has not been independently verified by HarbourVest. Unless otherwise specified, all information is current at the time of issue. Any opinions expressed are those of HarbourVest and not a statement of fact. The opinions expressed do not constitute investment advice and are subject to change.

Past performance is not a guarantee of future success and there can be no assurance that investors in funds will achieve the returns discussed herein. Investments in private funds, involve significant risks, including loss of the entire investment. Before deciding to invest in a fund, prospective investors should pay particular attention to the risk factors contained in the fund documents. Investors should have the financial ability and willingness to accept the risk characteristics of an investment in a fund.

Certain information contained herein constitutes forward-looking statements, which can be identified by the use of terms such as “may”, “will”, “should”, “expect”, “anticipate”, “project”, “estimate”, “intend”, “continue”, or “believe” (or the negatives thereof) or other variations thereof. Due to various risks and uncertainties, including those discussed above, actual events or results or actual performance may differ materially from those reflected or contemplated in such forward-looking statements. As a result, investors should not rely on such forward-looking statements in making an investment decision.

For additional legal and regulatory information, please refer to important-legal-disclosures.

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