Friday Letter Taking a stand on fees

Conventional wisdom has been that regardless of how loud investors shout about fees needing to come down, top quartile performers will still command whatever they ask. But recent PEI data suggests some LPs are taking a harder stance.

Earlier this week, we released an institutional investor sentiment survey, an analysis of the views of 100 leading investors across the asset class.

Perhaps most notable was the strength of LPs’ feelings on fees.

The vast majority (87 percent) of investors said they would now reject a potential manager’s fund offering if their fees (or carried interest) were excessively high. A sizeable number (38 percent) suggested this would even hold true for top-performing managers.

That contrasts with the assumption that the industry’s top quartile firms will pretty much always be able to set whatever terms they like, irrespective of investor sentiment.

This has been changing the private equity industry in a couple of important ways. For one, transaction and portfolio monitoring fees are no longer accepted without question by investors. The ‘classic’ 2-and-20 management fee and carry model is becoming less and less common; LPs are demanding (and usually getting) a better deal.

While a handful of the industry’s veteran, global players may still have more investors than they can accommodate clamouring for access to their funds no matter what, that looks set to become the exception going forward rather than the rule. The number of separate account arrangements that have been struck in recent months by some of the industry’s large private equity firms and investors are perhaps testament to that change already getting underway.

As investors continue to be spoiled for choice with private equity firms, and fundraising conditions remain challenging, fee structures are bound to play an increasingly bigger role in a GPs’ ability to attract new investors and retain existing ones.

If an LP has the choice of numerous different firms with similar strategies, and especially if they all report top quartile performance (which is not an uncommon occurrence and can be difficult to verify, many LPs grumble), the prospective investor is going to start looking harder at factors other than performance to influence the decision.

Fees, or more broadly alignment of interest, surely will be top of list – and will cause a number of managers to be turned away.

The report can be accessed here.

Also a reminder, today is the last day for Operational Excellence Awards submissions.