At the heart of the private equity model is the notion that GPs are incentivised to maximise returns for their investors. This is due to the way the private equity fund model aligns sponsors with their LPs.
As the make-up of the LP universe evolves to allow more non-institutional investors to gain access to the asset class, this expansion of investor type means that fund sponsors will have to rethink how traditional forms of alignment may change for certain
“Fundamentally, institutional investors invest on different terms than retail investors do,” says Tarun Nagpal, founder of alternatives technology platform S64. He adds that it is generally unusual for both types of investors to access any given PE portfolio via the same legal entry point. Increasingly, retail investors and institutional investors are going to find themselves in the same vehicles, particularly with semi-liquid products, he says.
Power to negotiate
Market sources tell Private Equity International that the increasing democratisation of private equity is playing out in two main ways, particularly when it comes to the ways individual investors are accessing the asset class. The first is that GPs are using feeder funds to channel private wealth and high-net-worth-investor capital into their main vehicles – a method that does not necessarily impact the two and 20 model.
The second way is that individual investors are using dedicated vehicles, such as Blackstone’s private wealth-focused Blackstone Private Equity Strategies Fund, to invest directly in private equity.
Market sources that PEI spoke to for this report stressed that non-institutional investors – be they individual investors via defined contribution or 401(k) plans, or high-net-worth-individuals via private wealth channels with banks – typically have less negotiating power than large institutional investors. This means it can be trickier for them to push GPs to put more skin in the game.
Sabina Comis, a partner at law firm Dechert who specialises in tax and fund formation, says retail investors investing at scale will likely be able to push management fees down below the traditional 2 percent. When GPs go into a room and negotiate with LPs, the main thing up for discussion is the management fee, she points out.
“LPs do feel that the fee is sometimes part of what they are giving out to the GP and to the team,” she says. “A 2 percent [management fee] like you have in the private equity world is unlikely to be the norm in a fund that is mainly retail-orientated.”
Carried interest could also come down as GPs accept proportionally smaller upside of a larger pie, according to Comis.
“It is likely that retail investors will push harder for what is left on the table for the GP,” she says.
Ardian is one firm making a considerable push to expand its investor base past institutional investors, with its sights set predominantly on private wealth capital – an area it hopes could account for anywhere between 20 percent and 30 percent of the capital in its funds in time, the firm tells PEI. Jan Philipp Schmitz, head of Germany and Asia at the firm, says the fundamentals of alignment when it comes to non-institutional investors are the same as with institutional ones, in that Ardian aims to deliver good risk-adjusted returns for end clients.
“That is the same for institutional investors as for private wealth clients,” Schmitz says.
According to Erwan Paugam, head of private wealth solutions at Ardian, working with private wealth clients can even mean the GP is more sensitive to alignment issues than it is with institutional ones.
Ardian is extra cautious when it comes to making sure end investors understand what they are investing in, Paugam says. There is an added layer of making sure they are investing in a secure environment with the maximum level of information and right level of advice, he adds.
“Sometimes we’re going to say no to certain investors or present things in a way that is a bit more careful than we could have, just to make sure investors know what they’re doing and what risk they are taking.”
When it comes to a non-institutional LP base, visibility on re-ups into a fund is arguably less clear, market sources tell PEI. Where a GP can be relatively confident that its longstanding sovereign wealth fund LP client will seek a similar or slightly larger allocation in a successor fund, a more disparate LP base comprising individual investors can result in less certainty.
“For a retail investor, depending on which retail investor you’re referring to, it’s a bit more of a challenge,” says Dechert’s Comis. “You’re not quite sure that two, three years down the line, that individual will have the money to re-up.”
The result is that sponsors will have to adjust their investment policies accordingly and factor this into their business and fundraising plans, Comis says.
“You will have to account for the fact that maybe you can’t [rely on] the re-up, or you can’t [receive] it as quickly as you want to.”