Hamilton Lane is seeing more of its funds move toward a deal-by-deal structure and away from the European waterfall structure, its vice-chairman has said.
Speaking on the firm’s latest quarterly earnings call last week for the period ending 30 June, Erik Hirsch said the firm’s growth in separately managed accounts and evergreen funds has meant a move to the deal-by-deal model.
“If you think about the carry as kind of a pie chart…if you went back in the firm’s history, that pie chart would have been almost exclusively a European waterfall,” Hirsh said. “There would have been very little diversification in that pie chart.”
He added that this structure was in all of its vehicles, from its flagship funds to co-investments and secondaries vehicles. “If you look at the growth in the business and other areas where we are picking up carry-generating dollars, it’s really two places. One is in separate accounts that have transactional components to them and a growing number of those are more on a deal-by-deal model, just given the structure of the separate account. And the second place that we think over time we will continue to generate meaningful carry dollars is in this retail evergreen. That is by nature of the structure a deal-by-deal environment.”
Hirsch continued: “Now, we’ve also said that we’ve only been in that business for two years. And so, the first deals that we’ve done in there are at best two years old…When you look at what the average exit is for a private asset in today’s market…you’re running about four-and-a-half to five years. So I think over time that pie mix is going to change, where you will see a growing proportion of our carry coming in more of that deal-by-deal and American-style waterfall.”
The US-style deal-by-deal waterfall entitles managers to carried interest following the sale of each investment in a fund after returning LPs’ capital contributions plus the preferred return on those amounts. A European-style whole fund waterfall, on the other hand, is when carried interest is paid out at the end of a fund’s life.
In 2019, the Institutional Limited Partners Association released a a free-to-use ‘model’ limited partnership agreement – a dummy legal contract. The terms of the document reflect those described in ILPA’s Principles 3.0, and as such feature a European-style “whole of fund” waterfall – as opposed to the more GP-friendly deal-by-deal option.
“We obviously think that’s the best model, because it reduces clawback risk and other issues,” Chris Hayes, senior policy counsel for ILPA, told Private Funds CFO at the time. “But we do want to be responsive to the marketplace and our goal in the future is potentially to release a deal-by-deal waterfall down the line.”
Hamilton Lane’s customized special accounts and specialized funds have been “the most significant driver” of its business, Hirsch noted during the call. These two components made up more than 80 percent of its management and advisory fees as of end-June, which stood at $43 billion, an increase of nearly $4 billion year-on-year, according to earnings materials.
Taken separately, $2.1 billion of net fee-earning AUM came from its customized separate accounts and $1.7 billion came from its specialized funds, which includes its fifth direct equity fund, fifth secondaries fund and sixth credit fund, among others.
Growth in these two segments continues to be driven by re-ups from existing LPs, commitments from new LPs, growth in the firm’s existing fund platforms as well as raising new specialized products.
Hirsch also noted the firm is controlling the piece that it can control given the market environment – that is, “doing good investments”.
“When you look at the rise in the unrealized value, I think that’s very indicative of we’re putting the money to work in a smart way,” he said. “Our clients are very much benefiting from that and then us sort of aligned with them are also benefiting on the carry side.”
Investor demand for the firm’s evergreen products “continues to be strong”, Hirsch added. The firm’s evergreen platform exceeds $1 billion, with investors from 18 countries across the Americas, Asia, Europe, the Middle East and Australia. Total inflows for its evergreen platform reached nearly $500 million in the first seven months of 2021, already exceeding the entirety of 2020.