A surprising admission from Mr. Fund of Funds

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Was at a terrible conference early this week, when I heard something amazing.

It came from a guy who runs a fund that invests in other managers’ private equity funds… in other words, a “fund-of-funds”.

Someone in the audience, presumably an aspiring fund manager, asked Mr. Fund-of-Funds how much of a co-invest he wants to see from the fund managers. In other words, he wants to know how much of their own money asks the managers to put in.

Ordinarily, investors like managers to invest a lot of personal money in their own funds, to make sure they’re incentivized to do a good job. (Honestly, it bogles my mind that anyone would take money from a partner and then do anything less than the absolute best he/she could, but anyway…)

Mr. Fund-of-Funds had a superficially counter-intuitive take. He said something like: “I don’t like managers to have too much of their own money in their funds(!), because then they start acting like a family office and refusing to sell.”

If you think about it for a minute, this actually isn’t so surprising. Mr. Fund-of-Funds needs his underlying fund managers to sell so they can return capital to him and he can, in turn, return capital to his investors. So I get why he wants them to sell.

The interesting part is at the end, the part about how people who actually put in their own capital don’t like to sell.

Of course they don’t!! Selling vaporizes capital, in the form of transaction costs and taxes. It forces capital allocators to find new deals to put their money in… when they had a perfectly good investment already. And it robs capital allocators of the principal benefit of a great investment – slow, steady compound growth of cashflow and asset valuation over decades.

If you know me at all, you know we, as a rule, do not sell assets. We buy them, we fix them up, we refinance to return capital to our investors, and then we hold forever. Don’t think we’ll get any capital from Mr. Fund-of-Funds… but plenty of other capital allocators think like us.

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