Are funds safer than single asset deals?

Welcome back and happy Friday!

“Invest in our fund, it’s safer because we provide you diversification across a bunch of deals”

I’m sure I’m not the only one who has heard this argument, whether it came from a fund or a feeder fund (I recommend you spend some time reading about the latter here).

Today we’ll dissect to which extent it’s true – perhaps single asset deals don’t make as much sense and LPs should focus more of their time on funds?

Some say this is true.. do you agree?

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First, I want to remind you of the three pillar framework – it’s a good idea to at least glance at these articles before you continue to familiarize yourself with how I view and analyze LP investments.

• Execution - track record and counterparty risk

• Alignment of Interests - coinvest, waterfall, and fees

• Property - valuation and business plan

The only way to compare one deal to another is to compare it across these pillars – and the same holds true if you’re comparing a single asset deal to a fund with the exception of ONE variable – discretion.

What do I mean?

Well, with a single asset deal you have to vet the three pillars, but you know what asset you’re investing in.

With a fund, by contrast, this is typically not the case.

You’re usually investing in a GP who will go out and deploy that cash. The GP will typically send you updates along the way as acquisitions occur, but you won’t have the option to opt in (or out) on any given deal ... since your investment sits at the fund level.

So, what this means is that in order to invest in a fund you have to have a much higher degree of trust in the GP compared to the single asset deal. By extension, this also means that the investment mandate of the fund needs to be clear (pay special attention to cases where the GP is able to invest in their own deals – murky waters to put it nicely).

Alright, fair enough – so you need more trust. But isn’t it also true that funds have some benefits?

Yes, they do! I’ll explain two of them specifically:

Fund Benefit #1: Avoid Single Asset Risk

One of the biggest risks of a single asset syndication is doing all of your due diligence only to get caught on something that was outside of your control. Some examples:

• You invested in the best deal ever, but a fire broke out and the insurance proceeds didn’t get you back to your original valuation you were expecting at exit

• You did phenomenal due diligence, but something drastic happened in zoning or tenant laws in the area after you bought the property which had a material negative impact on valuations

• As you can imagine, the list of things that are outside of your control goes on and on…

But how does a fund help with this?

Well, if you invested the same $100,000 into a fund and it held the same property, the $100,000 investment gains would be offset by the performance of another property.

You can see vividly how such a benefit could be huge – perhaps the GP invested in a few properties across different markets and one of them underperformed … with a fund structure, all the returns are – in a sense – comingled together.

Fund Benefit #2: Crossed Promote

One big benefit of having the returns being comingled together is that the promote is crossed too!

All else equal, an LP is actually better off from a fund structure because the promotes on all of the properties are crossed.

I’ll walk you through a detailed example (ps if I haven’t lost you yet and it’s the weekend, you must be part of the nerd club - welcome!):

I hope this helped you understand the benefits of the fund, while also understanding its risk.

It goes without saying that even if you’re investing in a fund, you shouldn’t assume that this will do your diversification for you - as I try to repeat as many times as I possibly can, you should diversify across many GPs and think critically about how much you allocate to illiquid alternative investments at large.

All else equal, the comparison between single asset deals and funds can be boiled down to the fact that the first pillar (Execution) must be trusted a lot more in order for you to commit to a fund … but once that’s in place, you will certainly feel the two benefits mentioned above.

I look forward to your feedback!

I advise LPs on existing and potential positions and write articles here weekly on what I see in the marketplace that could help you invest better. You can find me on LinkedIn or Twitter.

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