Partnerships are a quaint notion. Amid a shift to greater shareholder power and unprecedented scrutiny of company boards, they appear an anachronism.
Yet, in the fund management world at least, many investors attest to their trustworthiness and ability to outperform. Is this trust well based and do partnerships really possess skills lacking in other investment models?

Partnerships range from box room boutiques to large, diversified investment firms. The equity is sometimes split between two or more founders, but more frequently there is a majority owner and other partners with much smaller minority stakes. There may also be a seed investment shareholder or sleeping partner.

It is clear why investors like the model, says Jacques de Saussure, of Pictet, a Swiss private bank which has eight unlimited partners and 30 others with limited liability.

“First we are private, so there is no pressure from shareholders,” says Mr de Saussure. “As partners with equity that ties us to the firm’s fortunes for the longer term, we have a long-term perspective which matches that of our clients. The partnership structure also gives us stability – clients hate changes in key people such as portfolio managers.”

Some investors say partnerships, particularly smaller ones, simply try harder. “One of the differences we notice is that where a firm is owned by two or three people they really have to prove themselves, to show they generate better returns than their peers,” says Fred Ingham, head of international hedge fund investments at Neuberger Berman.

The trouble is that strong investment cultures are often built on the talents and efforts of one or two individuals, creating key-man risk. “Clever, thoughtful succession planning is a good thing, but real investment talent is rare,” says Will Pearce, a multi-strategy portfolio manager at Russell Investments.

Rating investment staff is a key component in Russell’s investment process. Mr Pearce adds: “We pay careful attention to the investment professionals we believe generate most insight and are mindful where an investor has carried the firm, made the best calls, run the flagship product and is synonymous with the organisation.”

In firms where there are a number of partners, perhaps dozens, succession is a big issue for long-term investors. “It can pose a big problem if the older generation moves out of a partnership and feels they should receive market price for equity,” says Mr Pearce. “It’s a reasonable stance to take, but for the younger generation it comes at a high cost and can cause dislocation in terms of the steady growth.”

Pictet believes it has solved the succession problem. “We have had the same process for two centuries,” says Mr de Saussure. “The key is to bring in young partners at book value, not market value. That way, the return on equity can be sufficiently high so they can pay back the debt they may have incurred to acquire their stakes. But when they get out, they also get out at book value. They understand this and it makes transmission possible.”
Succession is not the only issue stemming from the concentration of power in partnerships. Investors also harbour concerns that a dominant individual has the opportunity to run a firm as a personal fiefdom.

“We want to assure ourselves that one person doesn’t have all the power,” says Jason Collins, European head of research at SEI. “You want to be protected from fraud at the most basic level, so from an operational risk perspective there must be a segregation of duties.”
But Mr Collins also sees advantages in having a powerful lead partner. “It can work better when there is one person who is the majority shareholder,” he says. “There are not many successful structures where there are three to four people pari passu. Friction frequently develops between strong-minded people.”

For investors wary of potential key-man and fraud risk in tightly owned partnerships, other partnership models do exist. Brown Advisory, for instance, a Baltimore-based investment firm with nearly $32bn in assets, has given all its 290 employees a share in the business and seeks to offer them all “meaningful equity”. Legally, the firm is not a partnership, but it operates as one.

“No one here owns more than 10 per cent of the firm,” says Mike Hankin, Brown Advisory’s chief executive. “We have consistently given equity to promising young people long before they prove themselves. Many firms make people prove themselves over a long period and eventually make them partners. The problem with that approach is, given the tax implications, if you wait until employees prove themselves it’s hard to give them meaningful equity.”

Awarding equity on day one, Mr Hankin argues, facilitates staff hiring and retention. Employees can build up serious equity before they become partners, and there is also little hierarchy so staff are motivated to work with each other rather than competing for status.

The benefits of widespread ownership are most apparent in times of stress, Mr Hankin says, pointing to the final quarter of 2008. While staff at many competitors were focused on protecting their jobs, Brown Advisory was formulating plans to protect clients’ wealth, he says.

“In the fall of 2008, we talked to our staff and told them short-term incentive compensation might tail off for a while, but we are not letting anyone go. The number one focus was to protect the ship and protecting clients was the way to do that.”

Staff, including senior partners, were told to repeatedly contact clients, to reassure them or reposition their assets. “We measured on spreadsheets how we talked to clients and whether we were asking the right questions,” says Mr Hankin. “By the end of the process, we felt we really understood their worries.”

Indications from investors are that partnerships may deliver better results. A study in the UK by CoreData Research showed that the flatter management structures of independent asset managers lead to lower costs. With an average efficiency score of 77.3 per cent from 2004-2011, independent managers outperformed bank-owned and life and pensions-affiliated competitors, which scored 70.2 per cent and 65.3 per cent respectively. CoreData noted that independent businesses have smaller workforces, which not only reduces costs but provides less opportunity for poor performers to hide.

Pictet is one house to have implemented a flat structure. “Our top people all run money,” says Mr de Saussure. “In some large banking institutions, the top management has limited understanding of the culture of asset management and has a totally different agenda to the investment professionals.”
While there is little hard evidence that funds run by partnerships produce superior investment returns, there seems to be agreement that smaller firms in general outperform. “Studies we have carried out find a relationship between low levels of AUM and returns,” says Mr Pearce. “The motivation can be higher in a small organisation and decision making is more fluid.”

Phil Davis
Last updated: October 7, 2012 4:32 am
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