Co Investment Strategies Skin In The Game

Marie Barber, Managing Director, and Michael Beart, Director, in our Regulatory Tax Advisory practice discussed in HFM Week the best co-investment strategy for asset management firms.

Below is a copy of the article, which is also available on HFM Week’s website for subscribers.

For asset managers there has been a long-standing expectation that they should be prepared to put their “money where their mouth is” and invest alongside external investors to better align interests. Co-investment is an expectation not only held by investors but increasingly by regulators as provided for in the AIFMD and Ucits V remuneration codes. However, it is no longer only senior management that are expected to have skin in the game. Co-investment is increasingly used at a firm wide level as a platform for incentivisation, retention and risk management strategies.

Developing a successful approach to co-investment can be difficult, but is not out of reach to any sized manager. The sophistication of co-investment structures can vary widely from tailored bespoke structures to simple contractual agreements. Of paramount importance is designing a structure that is well understood by all stakeholders and importantly encourages positive traits in the behaviour of individuals.

Some of the possible solutions available include:

1. Contractual agreement
2. Deferral mechanisms
3. Non-cash awards
4. Phantom investments
5. Carried-interest vehicles

From experience no two coinvestment strategies are the same, however, most fit into these categories. To decide on the best fit for a firm the basic characteristics of a coinvestment solution need to be considered and prioritised.

Funding

Co-investment can either be funded through an individual’s remuneration package or out of their existing wealth.

The latter is not always possible or desirable on a firm wide basis, hence leading to an increase in the use of strategies to co-invest bonus pools and profits.

Discretion

If the co-investment strategy is incorporated within the remuneration package thought needs to be given as to whether there is scope to claw-back any amounts and if good-leaver/bad-leaver provisions are possible, i.e. an

individuals forfeit their co-investment?

Tax

It can be very complicated and is vital that you get it right as it will underpin the whole strategy. The timing and rate of tax suffered will depend on the structure adopted. It is important to determine the point when an individual

becomes entitled to value and the status of the underlying investments. The gap between income tax rates and

capital gains tax rates has a material impact on investment returns and considerations, like whether shares have

reporting fund status are increasingly relevant.

Administration

The complexity of a co-investment strategy can be an administrative burden and additional resourcing requirements need to be considered to address accounting, reporting, legal and operational requirements. A clear set of rules is imperative so all stakeholders know and understand the rules of the game.

Communication

The manner and timing of how the co-investment strategy is communicated is vital. Managing expectations during the implementation and legal pitfalls should be considered.

Cost

The upfront and ongoing costs of operating a co-investment strategy should be considered. If the coinvestment

strategy includes long term deferrals it is important to get a clear idea of the ongoing costs involved in running the strategy.

Segregation of Assets

While the business may be comfortable holding assets this can sometimes be undesirable from a regulatory perspective and in the eyes of beneficiaries. A third-party may be required to house assets in the meantime.

Plan Ahead

Think about how the strategy will work in practice and run scenarios to stress test the co-investment, e.g. for

exceptional performance or market turmoil. It is important to plan for both the good times and the bad.

In conclusion, developing a strategy that fits with the culture of the firm, though not always obvious at the outset,

is achievable. Time needs to be spent engaging with all the stakeholders and ensuring that it has a positive impact

on all parties building a stronger firm in the long-term.