SMA funds-of-one: an enduring alternative to commingled funds

Ongoing appeal of SMAs amid challenging fundraising years

Fundraising of traditional drawdown funds, on a global basis and across strategies, has generally been considered more challenging in recent years. Looking at the data, aggregate global private capital raised from 2021 to 2024 fell by nearly 40%¹. Despite this overall decrease in fundraising, the data show that institutional investors have increased their private markets allocation (i.e., an increase of 10% over 2014 to 2023) and decreased their public markets allocation (i.e., a decrease of 5% over the same timeframe)². There are various reasons for this apparent contradiction in the data, which may also help explain the rise in nontraditional fundraising models, such as SMAs.

As capital is increasingly being funneled into a smaller selection of mega sponsors who have come to dominate the current fundraising landscape, and accounted for nearly half of all capital raised globally in 2024³, many emerging and mid-market managers in particular have been exploring alternative ways to fundraise other than through the most traditional fundraising model of commingled funds. One fundraising option that has continued to attract capital among all sizes of fund sponsors is raising capital through SMAs, a popular investment tool which 40% of U.S. advisors are believed to have implemented into their practice as of 2023⁴—and which has enjoyed an increase in assets under management of 30% over 2017 to 2023⁵.
 

 
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 needs, and it can be attractive for sponsors who are looking 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 used 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 needs 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 targeted, 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-ended fund with no prescribed end date. For more information on open-ended fund structures, please refer to our article, “Open-ended 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 depend 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 making 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 end 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-cause 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 big check to make 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 negotiating 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 because 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, together 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 negotiation 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 need 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 exchange 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.