One of the consequences of the slowdown in fundraising caused by the recent pandemic seems to have been an increase in the use of Separately Managed Accounts ("SMAs") as investment vehicles. Whilst there has been some recent recovery in fundraising it is widely accepted that the differing economic situations globally, as a result of countries' varied responses to the crisis, will make it difficult to predict fund size in the short to mid-term. If you are a large institutional investor therefore (e.g. a sovereign wealth fund or a pension scheme), in the midst of such uncertainty the flexibility and personal tailoring that a SMA offers is certainly an attractive proposition.
Advantages of SMAs
Of course there is a cost element to SMAs which will rule out their suitability to certain investors, but for those LPs for whom the benefits outweigh the cost burdens, what are some of those benefits?
- Flexibility: a SMA offers its investor a customized investment vehicle. The investment strategy will take account of personal risk appetite and preferred asset classes and/or sector focus (e.g. assisting in ESG considerations).
- Fees: the pricing (usually based on value of assets under management) can in fact be advantageous to the investor due to the efficiencies of the structure.
- Reporting: the SMA's reporting can be structured so as to mirror the investor's own internal reporting requirements, resulting in administrative cost savings.
Structuring of SMAs
A SMA will be structured as a single legal entity. In the Channel Islands a SMA could be structured in a number of ways but we are increasingly seeing a Guernsey protected cell company ("PCC") used, alongside the traditional GP/LP structure. In a PCC context, the PCC will be formed by the sponsor and each cell can be used as a SMA for separate investors, or for different asset classes of an investor. Whilst the GP/ LP structure is perhaps more commonly encountered in Europe and the US, the Guernsey protected cell company offers an alternative with further potential cost benefits.
Fund Finance to SMAs
Fund finance options are available to SMAs as they would be to more traditional "funds", and in the last few years there has been an increased appetite from banks and credit funds in the market to provide SMA financing. Subscription credit facilities continue to gain popularity for the well documented reasons (liquidity/ cash flow management, low risk level, reduced administrative burden on managers etc). Onshore counsel are now well versed at structuring SMA subscription facilities and advising sponsors and lenders on how those differ from the traditional "fund" facility, but from an offshore legal perspective the use of such facilities by SMAs also gives rise to some security structuring anomalies depending whether you are dealing with a PCC or GP/LP structure.
With a Channel Islands GP/LP structure the security package will include the grant of Guernsey or Jersey law security, as applicable, over the rights of the GP and/or LP against the limited partners pursuant to the limited partnership agreement. These rights will include, inter alia, the right to make capital calls, the right to receive capital contributions and the rights to enforce payment of capital contributions and exercise any remedy with respect thereto in accordance with the terms of the partnership agreement.
In the case of a Guernsey PCC, a corporate entity, there will be no limited partnership agreement and so the ability of the PCC to call for capital can arise in one of two ways, either (i) the investor can subscribe for a specific quantity of partly paid cell shares, and the PCC can make calls with respect to those shares up to a maximum commitment amount (as set out in subscription agreement), or (ii) the investor can subscribe for a specific number of fully paid shares at the outset and agree, in the subscription agreement, that on written demand received from the PCC it will subscribe for further additional shares at an agreed price per share up to the maximum commitment amount (as set out in the subscription agreement). To protect against a scenario where a PCC might be prevented from issuing shares in certain circumstances, the subscription agreement should contain the agreement of the investor that it will not be excused from funding in such circumstances and shall still be obliged to fund notwithstanding that it will not be able to receive shares in consideration.
Whilst SMAs have become increasingly relevant in the European market in recent years it will be interesting to see if the impacts of Covid-19 on the fundraising market continue this trajectory as currently predicted. The benefits of SMAs to large institutional investors are clear and as the banks and other lenders in the fund finance space innovate and adapt their facilities to suit the particularities of the structure (both from a facility and security perspective), we expect to see an ever-increasing range of finance products available to these vehicles.
Originally published August, 2020.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.