General partners are “overpaid”, according to Stephen Feinberg, head of Cerberus Capital Management, and firms should be paying back LPs their committed capital, plus a preferred return, before general partners start to collect carried interest.
Feinberg, speaking at an industry conference in New York earlier this week run by Dow Jones, said Cerberus doesn’t collect any kind of deal, monitoring or management fees from portfolio companies. He said the firm “back-ends” carry payments, so partners don’t collect until LPs are made whole.
“The alignment of interest at the back end, so when the GP makes a good return, the LP makes a good return,” Feinberg said. “To me, that’s the way the business should be.”
More LPs are asking for GPs to set up “European-style” waterfall distribution structures so LPs can get paid all their committed capital, plus a preferred return, before the GP starts to collect carried interest. Trade organisation the Institutional Limited Partners Association has called for this type of structure.
The alignment of interest at the back end, so when the GP makes a good return, the LP makes a good return. To me, that's the way the business should be.
Feinberg had a very candid discussion with Dennis Berman, an editor at the Wall Street Journal, at the conference, in which he talked about mistakes Cerberus made and the opportunities the firm is seeing in the European debt crisis.
Cerberus brought too many “cyclical” businesses into its investment portfolio, which particularly hurt fund performance after the markets turned down in 2008, Feinberg said. Going forward, Cerberus will stick strictly to the mid-market when doing deals and not have as many businesses so sensitive to the broader economy.
“The mid-market is a good area for us, that’s where we want to stay,” Feinberg said. “We’ll be focusing on less economically sensitive businesses … our strength is in operational improvements and execution, we want to take out as much of the macro risk as possible.”
Cerberus is in the fundraising market, targeting $3.75 billion for its fifth fund, a dramatic decrease from the $7.5 billion it raised in Fund IV.
The firm is trying to convince limited partners that its very public investment implosions in Chrysler and GMAC Financial were not ultimately as catastrophic as they appeared. The fourth fund had been generating just above par returns, with a 6.51 percent internal rate of return as of 30 September 2010, according to information from the California State Teachers’ Retirement System.
The fund had a relatively amazing turnaround, considering it was generating an almost 30 percent loss in 2008. Cerberus took big hits on its mega-investments in automaker Chrysler, which went bankrupt in 2009, and GMAC Financial, the former lending arm of General Motors that required a $17 billion bailout from the US government. The firm has said it has broken even on the Chrysler investment, after selling a majority stake in lending and loan foreclosure business Chrysler Financial for $6.3 billion, and holding onto about $1 billion in assets.
Cerberus also made money during the downturn by making bets on residential mortgage bonds, which it bought at steep discounts. Those investments paid off, getting the firm gains of $952 million in 2010 and at least $850 million this year, according to the WSJ.
As a firm focused on turnaround investments, Cerberus is seeing a lot of opportunity in Europe, as institutions, including banks and corporations, try to raise capital by selling off assets, sometimes at cheap prices. Europe is “exciting”, Feinberg said.
“We’ve bought a number of portfolios already and [we have] a lot in the pipeline,” he said. Investments in portfolios of assets from troubled sellers makes sense as long as “you can price in some pretty awful macro-economic risk, otherwise it doesn’t make sense,” Feinberg said.