KKR offers preferred return for first time

The firm’s decision to offer a preferred return after years of resistance is symptomatic of the pushback LPs are showing on fund terms.

Kohlberg Kravis Roberts is offering a 7 percent preferred return on its latest North American fund, according to an NEPC report presented at the New Hampshire Retirement System’s December investment committee meeting. This is the first time the firm has offered any sort of preferred return, said a source with knowledge of the firm.

Preferred return is the minimum return a firm must overcome on an investment before it can begin to collect carried interest. Until now, KKR has resisted offering a preferred return, which many firms have had in place for years, one market source said. The decision to provide a preferred return for its North American XI offering may be indicative of a broader trend of limited partners pushing back on terms in general, from management fees to waterfall distributions, the source added.

However, it’s not clear if KKR established the preferred return because of LP pressure. KKR declined to comment.

Earlier this year, KKR endorsed to the Private Equity Principles, a set of best practice guidelines established by the Institutional Limited Partners Association calling for interest alignment, strong governance and greater transparency. The principles include a “standard all-contributions-plus-preferred return-back-first model”, which would require the repayment of LPs on all contributed capital plus a preferred return before the GP can collect carried interest.

KKR has shown a certain level of flexibility in negotiating with its LPs on North American XI. In January, the Oregon Investment Council was able to use its lengthy relationship with the firm to negotiate management and other fees down to lower than any previous Oregon commitment to KKR funds. The new fee structure will save the retirement system at least $2 million compared to terms on previous KKR funds, according to an OIC statement. 

The fund, which is targeting $8 billion and $10 billion, has yet to hold a first close despite getting support from two of its most loyal LPs – the OIC and the Washington State Investment Board – who have committed over $1 billion combined to the fund. In a third quarter earnings call, the firm’s head of global capital and asset management group Scott Nuttall said KKR has “direct line of sight to a sizable first close”. Bloomberg reported that the fund had raised around $4 billion as of November.

North American XI will use a similar strategy as its previous offerings, acquiring controlling ownership positions in mature companies. The firm’s 2006 fund, which raised $17.6 billion, was netting a 4.5 percent internal rate of return and 1.2x return multiple as of 31 March, according to the California Public Employees’ Retirement System.

KKR was founded in 1976 by Henry Kravis, George Roberts and Jerome Kohlberg and controls around $58.7 billion in assets under management as of 30 September, according to the firm.