Fee savings per unit of commitment against costs that do not shrink with size: the minimum mandate at which an SMA beats the commingled fund, and what erases it.
A separately managed account is worth it when the present value of its fee saving exceeds the costs the LP no longer shares with other investors. On illustrative terms, an SMA at 1.25 per cent on invested capital and 15 per cent carry, against a commingled fund at 2.0 per cent and 20 per cent, saves 7.541 per cent of commitment in present value; with 0.40m of setup and 0.40m a year of running costs, it breaks even at a commitment of 40.9m. At 100m it adds 112 basis points of net IRR.
Worked in full in The Private Markets Limited Partner by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Large LPs increasingly ask managers for an SMA: a single-investor vehicle that follows the flagship strategy on negotiated terms, often with more control over pacing and reporting. The fee schedule is the visible advantage. The costs are less visible, because in a commingled fund the LP shares administration, audit and legal expenses with everyone else, and in an SMA it pays them alone. Those costs barely depend on size, which is why there is a minimum mandate.
| Term | Commingled fund | SMA |
|---|---|---|
| Management fee, years 1 to 5 | 2.0% on commitment | 1.25% on invested capital |
| Management fee, years 6 to 10 | 1.5% on invested capital | 1.25% on invested capital |
| Carried interest (hurdle assumed cleared) | 20% | 15% |
| Fund expenses borne by the LP | 0.10% of commitment a year | All its own |
| Setup: legal and structuring | None | 0.40m |
| Administration, audit, reporting, oversight | Included above | 0.40m a year |
Capital is invested in five equal annual tranches and returned five years later, so net invested capital runs 20, 40, 60, 80 and 100 per cent of commitment, then falls back to zero. Fees are paid in addition to the investment calls. Cash flows are discounted at 8 per cent.
Management fees over ten years: fund 13.00% of commitment, SMA 6.25%. Saving 6.75 points.
Carry: gross profit 0.90 of commitment. Fund carry 20% × 0.7600 = 0.1520; SMA carry 15% × 0.8375 = 0.1256. Saving 2.64 points.
Shared expenses no longer paid: 1.00 point.
Undiscounted total 10.39%. In present value at 8%: 5.437% + 1.433% + 0.671% = 7.541% of commitment.
The basis does more than the rate. A 0.75 point gap in the headline fee would be worth about 7.5 points over ten years if both were charged on commitment; charging on invested capital is what turns the SMA's 1.25 per cent into 6.25 per cent of commitment over the life.
PV of SMA costs = 0.40 + 0.40 × (annuity factor, 10 years, 8%) = 0.40 + 2.68 = 3.08m (4.40m undiscounted).
Break-even commitment = PV of fixed costs ÷ PV saving per unit = 3.08 ÷ 7.541% = 40.9m.
| Commitment, m | Fund net IRR | SMA net IRR | Difference, bp | PV advantage, m |
|---|---|---|---|---|
| 25 | 9.13% | 7.99% | −115 | −1.20 |
| 40.9 | 9.13% | 9.14% | +1 | 0.00 |
| 50 | 9.13% | 9.47% | +34 | +0.69 |
| 100 | 9.13% | 10.25% | +112 | +4.46 |
| 200 | 9.13% | 10.64% | +151 | +12.00 |
| 400 | 9.13% | 10.84% | +171 | +27.08 |
Below the break-even the SMA is expensive: at 25m it costs 115 basis points of net IRR. Above it the advantage grows quickly and then flattens, because the fixed costs become negligible and the IRR gain converges on the pure fee saving.
| Case | Break-even, m |
|---|---|
| Base case | 40.9 |
| Running costs 0.25m a year | 27.5 |
| Running costs 0.60m a year | 58.7 |
| SMA fee on commitment in years 1 to 5 | 55.1 |
| SMA carry 20%, no carry discount | 58.6 |
| SMA deals return 1.85x instead of 1.9x | 59.0 |
| SMA deals return 1.8x instead of 1.9x | 105.6 |
Deal quality outweighs every fee term. At a 100m mandate, the SMA's entire advantage disappears if its portfolio returns 1.804x gross against the fund's 1.9x: a shortfall of 0.096x, small next to the normal dispersion of individual deal outcomes. An SMA that receives the deals the flagship fund passed on, or the tail of each allocation, can be expensive however good its fee schedule looks.
The common mistake is to compare the headline terms, 1.25 and 15 against 2 and 20, and stop. That ignores the costs the LP takes on by leaving the pool, so it overstates the case for small mandates, and it ignores the allocation policy, which decides whether the SMA gets the same deals at all. The allocation question belongs in the side letter: pro rata participation alongside the flagship, written down and tested, is worth more than another 25 basis points off the fee.
An SMA has a minimum efficient size set by fixed costs, here about 41m, and a maximum value set by deal quality. Negotiate the fee basis before the rate, budget the running costs honestly, and secure pro rata allocation. The same fixed-cost logic applied to co-investment is worked in what a co-investment programme actually saves, and the programme models for this book are in the free workbooks for this case.
The commitment at which the fee saving covers the SMA's fixed costs. In the illustrative case, 0.40m of setup and 0.40m a year of administration, audit and oversight cost 3.08m in present value, against a saving of 7.541 per cent of commitment, so the break-even is 40.9m. Running costs of 0.60m a year push it to 58.7m.
Partly the rate and partly the base. In the worked case the headline gap is 0.75 points of management fee and 5 points of carry, but charging 1.25 per cent on invested capital instead of committed capital is what does most of the work: management fees total 6.25 per cent of commitment over ten years against 13.00 per cent in the fund.
Weaker deals. At a 100m mandate, the SMA's whole advantage is erased if its portfolio returns 1.804x gross instead of the fund's 1.9x, a shortfall of 0.096x. If the manager allocates the best deals to the flagship fund, the fee saving is the smaller number.
This article is one calculation from The Private Markets Limited Partner. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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