People are the key variable in private markets investing, so when issues come up relating to the actions of the GP, it’s important to understand what options LP’s have. In addition, because the assets are private, there’s very little clarity and insight on what’s really going on inside the GP. Investors place a lot of trust in the GP, which is why they want to ensure they operate in a manner that is aligned with LP’s.

LP’s need to ensure that the key principals remain at the fund and focused on the strategy. If this does not occur, or there are issues with the GP, then LP’s should understand what options they have, including suspending the investment period or removal of the GP, if necessary.

These are my collected notes over several years of private markets investing. Each LP should think about what is important to their firm and make sure the fund agreements reflect those priorities. These are principles and concepts to think about and discuss, not explicit legal advice.

The following are my notes collected over several years of working with subscription lines within alternative assets. While not always the most critical issue, understanding sub lines and other lending facilities can help improve LP fund governance, performance reporting, and enable the LP to ask better questions during due diligence and throughout the fund life.

Overview

• Subscription lines are not a new phenomenon in private markets as they’ve been used for decades. They allow managers to borrow to fund bridge financings and then eventually call the capital from limited partners

• The ability to delay calling capital enhances the manager’s flexibility to execute deals and shortens the J-curve, enhancing the fund’s Internal Rate of Return (IRR), particularly early in a fund’s life, and therefore its competitiveness on a quartile basis

• Funds use credit lines to boost Net IRR's and accelerate carried interest, particularly in funds with European style waterfalls

• From an LP perspective, the use of these lines helps smooth cash flows and eases the administrative burden of responding to capital calls.

• Improves capital call logistics – small investment outlays more conveniently aggregated

Independent, critical thinking is an unnatural process, especially for investors. It’s easier to go with our gut instinct, instead of relying on the facts. It’s easier to go with our emotion than diligently follow the evidence. Above all, we gravitate towards stories and promises rather than logic and reason.

Carl Sagan was one of the great astronomers and scientists of the 20th century. He published more than 600 scientific papers, co-wrote Cosmos, the most widely watched T.V. series in American history, and wrote the novel Contact, which was later made into a movie.1

One of his most important efforts was his support for independent, skeptical thinking. It’s the application of the scientific method to our daily interactions. In his book, The Demon-Haunted World: Science as a Candle in the Dark, Sagan includes a chapter called “The Fine Art of Baloney Detection.”2 Sagan proposed 9 simple rules on how to apply the scientific method to better understand the world around us and protect against deception. It’s advice that fights against lazy thinking and raises our standard on what we choose to believe.

While many institutional investors have flocked to alternative assets, few have been able to translate these allocations into successful performance. Allocating is easy, performing is hard.

Bob Maynard, CIO of the Idaho Public Employees Retirement System, illustrates the difficulty of executing on alternative strategies:

All of these additional areas add complexity and require time for Boards and staffs, and are often not worth the extra effort unless there is a clear organizational commitment or belief in a certain additional approach that can survive changing Boards and staffs over the years that may occur before the extra efforts pay off. One of the most valuable resources of an investment organization is not the assets in the portfolio, but the time required of the Board and staff. After the basics have been accomplished, additional investment efforts in more complex areas have to expressly trade off the requirement of additional resources and time compared to the often problematic longer-term return benefits.1

ILPA recently hosted a workshop on scrutinizing fund terms during the recent COVID-19 epidemic. Given the sudden and drastic downturn, funds used levers that caught LP’s off-guard. Below are my notes on the biggest takeaways and areas of concerns for LPs

Overall approach

· Are we getting the transparency we need?

· What do we need to be proactive about

· Are there adjustments to be made with new commitments?

· What have we learned through the COVID experience?

Do we have confidence GP's are using the following tools in the best interests of LPs?

Here are my notes from ILPA’s 3/19/20 Legal Town Hall on Deal Killers. Several LP’s discussed the most common non-investment related issues they see. While all organizations have different levels of comfortability on these issues, it’s useful to see what risks LPs are seeing and their mitigation approach. These risks focus on issues besides the typical investment and fee concerns.

There’s no shortage of investors trying to guess the market bottom. Fortunately, it’s completely irrelevant to delivering exceptional returns through this crisis.

We’d all love to know when the market bottoms. We’d be able to load up on risk assets and see nothing but immediate gains. But successful investing doesn’t work that way. No one consistently calls the bottom. Some get lucky once or twice, but never in a systematic way. Mostly luck, not skill.

You’ll always be too early or too late. You won’t know the bottom until you look back with hindsight years later. So if you shouldn’t be timing the bottom, what should you be doing?

Stop trying to call the bottom and start trying to find value.

The limiting factor for investors is not their IQ, but their temperament, rationality, and independent thinking. As Warren Buffet says, "You don't need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with a 130 IQ. Rationality is essential. Even if you do have an IQ of 160, you should just give away 30 points to somebody else because you don't need a lot of brains to be in this business. What you do need is emotional stability. You have to be able to think independently."1

Investors who lack control over their temperament make foolish decisions during market extremes. They struggle to respond to unexpected events in a thoughtful way. Instead of approaching decisions in a calm and rational manner, they abandon their process and invest based on their gut. They can get lucky for a while, but eventually will fail. Even brilliant investors who get caught up in the euphoria of a market boom or the pessimism of a market crash will abandon what has worked so well for them. They can’t resist the overwhelming pressure to exert control and do something now, no matter how foolish in the long-run.

Great investors develop mental toughness through proper mindset and habits. These are 10 guiding principles to condition the mind for investment success.

1. They Don’t Worry About Issues Outside Their Control

Much of investing and life is outside your control. Wise investors learn to recognize what they can control and what they can’t. The things that can’t be controlled are ignored.

2. They Don’t Obsess Over Volatility

It’s a fact: every day markets go up and down. Trying to obsessively negate volatility usually worsens it. The value of every asset you own, including your own human capital, moves up and down every day. Only you don’t see it, so you normally don’t worry about it. Do the same for random market fluctuations.

3. They Don’t Judge Success by Short-Term Results

Today I’m writing about the most neglected yet important thing to successful investing -the command of investor psychology. Investing is one of the most complex and stressful activities we do. Most of us know the emotional toll investing takes when markets are volatile and unpredictable. Research from cognitive psychology, neuroscience, and behavioral economics has yielded the same insight: that not only do we make mistakes, but we make bigger and more frequent mistakes when under pressure. The resources that often try to help, like the media and professional investment advice, often end up compounding, rather than eliminating, the error.

Psychology is critical because we are human. We are not robots. We are not perfectly rational. We make mistakes. It’s especially in investing where we tend to make the same mistakes and exhibit the same poor behavior. We can document this behavior starting with the Dutch Tulip Bubble in the 1630s, all the way through the 2009 financial crisis, and now with the cryptocurrency bubble.