Pantheon has introduced performance-based management fees for its private equity products in the defined contribution market based on the public markets, as the firm continues to roll out the asset class into this new space.
Typically, private equity products have a 2/20 model, where 2 percent of a fund is guaranteed to be paid to the fund manager in the form of a management fee, and 20 percent of the fund’s profits is pocketed by the manager in the form of carried interest.
However, this 2/20 structure doesn’t work for the defined contribution market, according to Pantheon. There have been concerns and lawsuits against plan sponsors by retirement savers that the fees charged for their retirement plan investments are too high.
Unlike the defined benefit plans where employers are the members, defined contribution plans list individual beneficiaries as the members, placing a risk of class-action lawsuits against sponsors, which has been a rising problem within defined contribution.
The London-based fund of funds manager’s managing director Kevin Albert noted during a media luncheon on Wednesday that since the first class-action lawsuit against defined contribution plan sponsors was filed in 1998, there have been over 800 such cases. Most recently, there were three lawsuits filed against JPMorgan, Charles Schwab and Towers Watson, he said.
So Pantheon has introduced a new fee model that does away with the fixed management cost, and blending the management fee and carried interest into one performance-based fee.
“To address these concerns, we announced [this] performance-based pricing option,” Albert said. “This innovative approach is designed to demonstrate visible alignment between us and our DC client and directly addresses concerns about alternative assets, including private equity being an expensive asset class.”
Pantheon head of defined contribution Michael Riak said at the same luncheon that Pantheon’s private equity strategy used in retirement plans in defined contribution markets would earn performance fees only when the strategy beats its benchmark, the S&P 500.
He explained that if the Pantheon strategy fund, which is marked to its net asset value (NAV) on a daily basis, increases 9 percent from its previous day’s closing NAV, and the benchmark increases just 3 percent, there is a 6 percent outperformance by Pantheon. By way of this performance-based pricing method, just one-third – a figure decided by Pantheon – of that 6 percent outperformance will be transferred to a reserve.
This reserve is where the outperformance fees sit, instead of going directly to Pantheon immediately. It is structured for days when the Pantheon strategy underperforms the benchmark. In that case, one-third of the underperformance will be transferred back from the reserve to the strategy fund.
“With the performance-based fees, if we perform, both the clients and Pantheon benefit,” Riak said. “If we don’t perform, we don’t benefit and the money will be returned to the fund itself.”
He added that the performance-based fee is paid directly to Pantheon from the reserve if the absolute performance is positive for a quarterly period. Even then, the fee is gradually paid to Pantheon throughout eight calendar quarters in installments because there must always be positive amounts in the reserve.
This pricing method benefits clients in that they are not paying a fixed 2 percent management fee, as would be the case in traditional private equity, but rather rewarding the manager only when the fund outperforms the benchmark.
Albert said Pantheon began a discussion three years ago around providing the defined contribution market access to private equity, looking to create a platform with daily pricing and transparency. In 2013, the firm hired Riak, who was formerly director of savings and affiliate plans at Verizon Investment Management, as its head of defined contribution.
Pantheon isn’t the only private equity firm bridging the gap between the asset class and the defined contribution market.
Swiss-based asset manager Partners Group entered the defined contribution market in December 2015, with the launch of evergreen defined contribution funds in the US, the UK and Australia, as reported by PEI.
Last month, Pantheon released a study concluding that a retirement saver could be missing out on almost $180,000 by not including private equity in the retirement plan.
Echoing that study, Albert said at the luncheon: “We believe that defined contribution plan savers should have the same advantages and access to the same investment strategies that have been available in the defined benefit market for the last 40 years, so they can accumulate the maximum amount of assets for their retirement.”