When compared to traditional commingled funds, SMA funds-of-one can be a particularly attractive option for investors who require an investment solution tailored to their specific necessarys, and it can be attractive for sponsors who are viewing to build a deeper relationship with a particular investor or otherwise raise capital for deployment. Despite the differences from a traditional commingled fund, a fund-of-one mirrors the operational flow, governance and structure of a traditional fund.
This contrasts with another frequently utilized type of SMA, which is the investment management agreement (IMA). With IMAs, there is no separate investment vehicle formed, but instead, the investor retains direct ownership of the assets in its own name, and the investment manager is given the authority to manage those assets through contract. IMAs and funds-of-one bring about many of the same characteristics and key considerations, which we discuss below.
Characteristics of funds-of-one and key considerations
Customization
One of the key benefits of a fund-of-one from the investor’s perspective is that it can be customized and tailored to suit the specific necessarys of the investor, including with respect to the fund’s investment strategy and restrictions, the duration of the fund term, any bespoke reporting requirements of the investor, as well as any other specific legal tax, regulatory or other structuring requirements of the investor. The foregoing can be extremely narrow and tarobtained, something the investor may not be able to find in a commingled fund that is set up to attract multiple investors. It is not uncommon for funds-of-one to be structured as an open-concludeed fund with no prescribed conclude date. For more information on open-concludeed fund structures, please refer to our article, “Open-concludeed funds part 1: a new way forward for private market funds”.
Governance rights
Investors generally have more oversight over the fund’s investment activity in a fund-of-one versus a traditional commingled fund. For instance, funds-of-one may provide the investor with an opt-in right or a veto over investments, which may (for legal, tax and other reasons) be structured as a failure to fund a capital call instead of an approval right on a particular investment. Investors should be wary of the implications that exercising this level of investment authority might have on their limited liability status, which will depconclude in part on the jurisdiction of the fund and its governing laws. We have seen, for instance, certain investors sometimes prefer Manitoba, Delaware or Québec limited partnerships in situations where such investors are seeking to have more control over investment decision creating given the impression that these jurisdictions offer better limited liability protection. For more details on how limited liability considerations vary by certain jurisdictions, please refer to our article, “Ontario limited partnerships: a globally favoured jurisdiction for private funds”.
In addition, investors in a fund-of-one may expect a stronger LP remedy package than what they would generally expect in a pooled fund context. GP removal rights, particularly on a no-fault basis, can be particularly sensitive to fund sponsors in the fund-of-one context, given the sponsor is setting up a custom mandate for an investor (and sometimes building a platform of resources to support it). The ability of the investor to conclude the commitment period on a no-fault basis is a particularly common remedy in funds-of-one, frequently following a designated honeymoon period. Quantum considerations in respect of GP commitment, carry haircut on for-cautilize GP removal, and management fee payment on fund termination and GP removal are often of discussion.
Economics
Typically, fund sponsors form a fund-of-one for an investor only if such investor is writing a relatively large check to create all the effort in forming the custom fund and running the custom mandate worth it. The large commitment amount of the investor can increase the investor’s nereceivediating leverage and expectations when it comes to management fees and carried interest rates (among other matters) within the SMA and, sometimes, across the sponsor’s flagship funds (i.e., a platform discount). From the fund sponsor’s perspective (especially for sponsors that are able to raise large amounts of capital), funds-of-one may be seen as a less scalable revenue stream, as it is difficult for a fund-of-one to match the size of a large, pooled fund—thereby impacting management fees and other economic considerations.
Conflicts of interest
Investors in a fund-of-one and fund sponsors alike should consider potential conflicts of interest that may arise becautilize of the sponsor managing the fund concurrently with its other existing mandates. Some key considerations include investment allocations between the fund-of-one and the other existing mandates, toobtainher with parameters around cross-trades and cross-investments. In addition, consideration should be given to the identity of the team that is going to be working on the SMA relative to the fund sponsor’s other funds, and whether they have sufficient time and attention capacity to be able to allocate accordingly (including in respect of each fund’s time and attention requirements, and any key person event triggers).
High administrative burden
Funds-of-one may be more costly to set up and more administratively burdensome for the sponsor to maintain when compared to commingled funds in the context of the total amount of capital raised. For instance, funds-of-one generally involve heightened nereceivediation of legal documents given the bespoke nature of the mandate. In addition, fund sponsors are often subject to more robust ongoing reporting requirements in a fund-of-one, given the necessary to accommodate the specific information requests of the investor. Sponsors should also consider whether they have the human resources (including the key persons as well as back office) necessary to successfully manage a fund-of-one in addition to their other existing mandates.
Bilateral relationship
Funds-of-one often involve collaboration, interaction and constant exmodify of ideas between the investor and the sponsor to a degree that is less commonly seen in a commingled fund. As a result, funds-of-one can be an invaluable tool for investors and sponsors to build a strong and lasting relationship, which could result in future opportunities that turn out to be mutually and exponentially beneficial.
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