Filtering investments by GP AUM

Happy Sunday!

I’ve written on the idea that people (wrongly) filter their deal flow by IRR. I think the second most common filtering algorithm is AUM and that’s what I’d like to tackle today.

The concept is pretty simple - if someone owns a lot of property, they’re likely more experienced than the guy who’s just getting started … right?

As you can already tell, the answer is “not necessarily” and I’ll explain why this is the case from the perspective of an LP.

Benefits of filtering GPs based on AUM:

• **Stronger relationships - **service providers (e.g. brokers) will typically favor GPs who can close with certainty and have closed many times before. Therefore, bigger firms may get preferential terms from brokers, lenders, and contractors. This can translate into earlier access to deals and better terms.

• **Institutional infrastructure - **larger managers typically have in-house accounting, asset management, compliance, and investor relations teams … these resources can reduce operational risk and provide LPs with better reporting and communication

• **Reduced key person risk - **with a trained team in place, the business can continue even if leadership pursues another career, asset class, or something health-related unfortunately happens to the CEO. Key person risk is one of those things that I don’t think gets enough attention within the world of lower middle market GPs.

• **Stability and financial backing - **a larger, diversified portfolio under management can mean the firm is less dependent on any single property or project. Cash flow from management fees can support the GP’s business through downturns or the lack of fees from a struggling property.

Drawbacks of filtering GPs based on AUM:

• **AUM doesn’t equal returns and is often inflated - **

• AUM is a measure of fundraising/closing success, not investment performance. Said another way, one could close on many buildings in fairly quick succession but end up not making their LPs anywhere near expected returns.

• There are a ton of ways in which AUM can be misstated - I go through many of the common “methods” in Track Record Audit. Take special note of entry/exit dates as well, as I think those are not created equal … more on this in the article.

• Scale can lead to misaligned incentives -

• As managers scale, they may prioritize asset gathering (sometimes this is due to fees, other times they just have an overabundance of capital) over disciplined deal selection.

• In a multi-billion-dollar portfolio, your deal might be just a rounding error - that can mean less attention and urgency from the GP.

• **Overlooking high-quality smaller managers - **emerging managers can bring many years of institutional experience, hunger, and unique opportunities because (relatively speaking) more is at stake for them personally. Many LPs who only filter by AUM never see some of the best risk-adjusted opportunities in the market. More on this in deal flow rules the world.

• **Deal baggage with no immediate answers - **

• Larger firms juggle dozens of assets and funds - problems in one deal can siphon attention away from your healthier investment.

• The opposite can also happen - if you’re invested in one of the “worse” deals of a larger AUM GP, it might be very difficult to reach a top person at the firm because their head is onto greener pastures.

As always, I hope this was helpful and I look forward to your feedback. The key question isn’t how much AUM a manager has - it’s whether their structure, incentives, and focus align with your objectives as an LP.

When you’re ready, I could help you in 3 ways - simply reply to this email if one is of interest:

• Limited Partners:

• ***GP-LP Match - ***a simple way for you to get more deal-flow that matches your precise LP parameters. You can join here in under a minute.

• Potential positions - you’re considering investing and need an independent opinion

• Existing positions - there’s a lack of communication, you’re concerned about fraud, or perhaps you got a capital call request and you’re not sure how to proceed. I have also helped LPs with a “post-mortem” analysis on deals that didn’t work out - it’s important to learn these lessons as opposed to just blaming the GP.

• LP Course - review 4 separate memos in 4 weeks together with me and other LPs to learn how to find good LP investments.

• LP Topics Seminar** - **an ongoing biweekly 1 hour meeting with other LPs where we'll go over investment decks, capital calls, distressed situations, and modeling. This is meant to provide a deeper look into existing LP investments. Please reply to this email if you’re interested.

• ***LP Community - ***free 2,800+ member LP Investor community on Twitter

• ***Find GPs ***in unique asset classes/geographies on my monthly intro post (see LinkedIn’s post as well for more)

• General Partners:

• Deck review - I’ll look over your marketing materials from the perspective of an LP and provide slide by slide commentary to improve your pitch

• Investment review - I’ll provide independent feedback on an opportunity you’re pursuing

• Capital call advisory** - **you suspect that you’ll need to make a capital call, but aren’t sure how to proceed or communicate the message.

• Other - anything from waterfall/fee advisory to disagreements between co-GPs on the proper path given a set of circumstances

• General Consulting: modeling, strategic advisory, underwriting training, etc.

If you’d like to speak on the phone, you can reach me at aleksey@centriocapital.com.