With bigger and stacked funds that operate multiple funds simultaneously, general partners are being over-compensated on fees for each fund, rather than being compensated on carried interest based on capital gains, HOOPP Capital Partners managing partner Jim Walker said.
Speaking to Private Equity International, he noted that the greater the fee income the less incentive to derive compensation from fund performance. This creates misalignment.
HOOPP Capital partners is the private equity arm of the Healthcare of Ontario Pension Plan (HOOPP), one of the largest public pension systems in Canada.
“When the industry started with smaller funds, you felt as a limited partner or as an investor that you were aligned with the general partner in that, if the general partner achieved returns, they would be compensated and if they didn’t achieve superior returns, they wouldn’t be well-compensated. That creates good alignment,” Walker said.
HOOPP Capital Partners partner Stephen Smith added that “it’s possible now for GPs to be very profitable without investors earning a decent return.”
Smith pointed to regulator involvement, noting “that is an indication that we as the LP community kind of lost control of this item probably over the last couple of decades.”
He added that greater transparency will be helpful to LPs in understanding the scale of this issue, adding that LPs failed to insist on transparency in the past 10 to 20 years.
Walker pointed out that fees may not be as hot of a topic in Canada as it is in the US, however.
“It may be less concerning in Canada because the funds are smaller,” Walker said. “So the misalignment isn’t as great: the bigger the fund, the bigger the issue.”
Another factor they think is hyping the fee issue in the industry is that private markets are becoming more efficient, compressing the returns investors realise. The fee burden on investments becomes more recognisable with compressed returns, Walker said.
“The fees should go down to create better alignment,” he said.
But they added that private equity is still a “great asset class” and the initial model upon which PE partnership structure was built is not the flaw. In fact, while HOOPP expects to up its direct investing in the coming months, HOOPP will not completely exit out of its fund investing business.
Walker said that currently, HOOPP invests about 70 per cent of its assets into PE funds and 30 per cent directly. In its lifespan, HOOPP has completed about $769 million in direct investments, according to its website.
“Funds are a good way for us to continue to get geographic exposure, industry exposure,” Smith said. “It’s an opportunity to invest with really talented teams, so that’s not something we see ourselves walking away from any time soon.”