London Business School’s Vasvari on the trade-off between PE fees and returns

Florin Vasvari, professor of private equity and venture capital at London Business School, shares his views on fees and cost management, how technology investments might be falling out of favour and why investors are shifting more capital into credit strategies in Europe.

Fees and expenses have been a key talking point among LPs, especially North American public pensions. Do private equity returns justify the fees GPs charge?

The problem with US pension funds is that they are running deficits when Canadian pensions are running surpluses.

When you are underfunded it’s not clear private equity is the right strategy because you need liquidity. A lot of the investors focus on fees – for a good reason – because it affects their expense ratio. You may be paying higher fees, but you also might be getting higher returns. You really need to balance benefits with the cost. It’s a trade-off there.

It’s the same problem with compensation. Regulations in the US capped the compensation of pension fund managers because they want to keep the expense under control, but that comes at the cost of not getting the right returns. On one hand you save on fees and expenses, but you are not getting the right returns.

I think the proposition should be: what is the benefit-cost balance there? If you look at the data from Preqin, the average PE fund buyout doesn’t lose money. The data over the last decade indicate that less than 15 percent of general partners that manage buyout funds lose money. In other strategies you can very quickly lose your money.

“You may be paying higher fees, but you also might be getting higher returns. You really need to balance benefits with the cost. It’s a trade-off there.”

Private equity at the end of the day continues to be an alternative asset class. Historically those pension funds that allocated much more money to private equity did better than those who didn’t invest in the asset class. An example is Ontario Teachers’ Pension Plan, which has generated about 20 percent returns per annum for the last 20 years. The reason why OTPP has these returns is because they do private equity and have a large direct investments programme. They made a trade-off. They said: ‘Yes we can either pay fees to managers or we can do our own investments.’

What are your thoughts on SoftBank Vision Fund and the huge amount of capital going into tech investments?

SoftBank Vision Fund is an unusual vehicle. A significant portion of capital is structured as debt, which is unusual. I think of them as a first-time fund manager with high-profile investments in innovative companies.

At the moment, it seems that the tech steam is running out. If you look at the equity markets, pretty much every tech company has lost about 20-30 percent of its value. The momentum is slipping on the tech side and people are becoming more vocal about technology companies because they monopolise their market position and, some might argue, misuse personal data.

How would you describe the secondaries market?

The private equity secondaries market is quite interesting. For a couple of years, the market has been driven by regulations. The fact that the banks had to get rid of all these positions to comply with new regulations held the market in the last few years.

Secondaries funds are also now getting into liquidity solutions. An example would be buyout funds that need to liquidate. Investors can take an entire portfolio in a buyout fund in year 11 or 12 and allow the managers to focus on their next set of funds. I think that’s very valuable in the market.

Any other trends in PE investing in Europe?

Credit strategies have been increasing significantly. Ten years ago, private credit funds were non-existent in Europe but today we have over 100 funds operating in Europe. The growth in private debt funds from 2011 to 2017 has been 70 percent year-on-year, according to a report from Hamilton Lane.

The data indicate that credit is the fastest growing strategy in Europe at the moment. In the past investors shifted capital from public equity to PE, VC and growth strategies. Now investors may be shifting from fixed income in public markets to private credit, which historically has provided returns of at least 10 percent.

Florin Vasvari teaches private equity and venture capital at London Business School. His work includes limited partners’ private equity allocations, valuation and performance measurement, secondaries, and aspects of risk management. He co-authored International Private Equity with Eli Talmor.