Oregon's fee showdown

With private equity fund terms and conditions having become a point of contention, the Oregon Investment Council (OIC), manager of the state's $56 billion pension, is flying the flag on behalf of limited partners seeking better deals.

OIC is currently negotiating a decrease in fees with Fisher Lynch Capital, a California- and Boston-based fund of funds manager, which is looking for a $500 million commitment from the pension.

The negotiations follow the drafting of a set of principles by OIC earlier this year to be used when considering making commitments to private equity firms. The guidelines are not meant to be policy to which the council is forced to adhere for each investment, a pension spokesman tells PEI. They are simply guidelines for the pension to take into account.

OIC started discussions with Fisher Lynch at the council's May meeting and negotiations on fee reductions are ongoing. Fisher Lynch at first declined to engage in discussion about changes to its fee structure, but “cooler heads prevailed”, Ron Schmitz, chief investment officer of the OIC, says.

Fisher Lynch's first fund was raised in 2005 as a joint venture between OIC and the Washington State Investment Board (WSIB). It raised $525 million, split between the two pensions.

The firm is now trying to raise $1 billion from the two pensions for its second fund. Oregon's investment would be made in two parts: a $300 million commitment this year and $200 million in 2010. The investment would not accrue management fees and capital would not be called until next year, according to documents from the OIC's May meeting.

WSIB recommended committing $500 million to the fund in January, but that investment has not yet closed, according to Liz Mendizabal, a spokesperson for the pension. It is watching to see how OIC's negotiations with Fisher Lynch proceed before making a final decision on the commitment, Mendizabal says.

COMMITMENT UNDER REVIEW
“We are obviously interested in what Oregon is going to do, [but] that doesn't necessarily change what we will do,” she says. Depending on the outcome of OIC's negotiations, WSIB may go back to the pension board for further review of the commitment, she says.

Fisher Lynch declined to comment. The principles Oregon has created are meant to “better align interests between general partners and limited partners, enhance fund governance, and provide greater transparency to investors”, according to a draft.

Carry should only be taken after 100 percent of capital, net of all fees and expenses, has been returned to the investor which has provided the vast majority of the risk capital. Management fees should not be a “major profit centre” for the firm. “Fees should be reduced for all but the most modest funds with larger funds taking larger reductions in ‘standard’ fees, acknowledging economies of scale,” the draft states.

Further, the GP's capital commitment to the fund should reflect a substantial amount of the net worth of the principals making up the general partnership, and a high percentage of the amount should be in the form of cash.

OIC also requests that the LP not be required to bear expenses of the GP related to entertainment, publicity, fundraising, office space, information technology, employment, personnel or other matters that are generally considered corporate overhead.

Limited partners should have more say over a fund, including allowing a majority of LPs to suspend or terminate the commitment period, remove the general partner or dissolve the fund, according to OIC's principles.

BARGAINING CHIPS
A sample of OIC's guiding principles:

  • • Carry should be on net profits after partnership taxes, management fees, transaction costs and all other ancillary expenses, rather than on gross profits.
  • • Carry should only be in effect after 100 percent of capital, net of all fees and expenses, has been returned to the investor which has provided the vast majority of risk capital.
  • • Each time a carried interest payment is proposed to be made to the GP or any GP affiliate, the books and records of the partnership shall be audited to confirm the amount of such payment.
  • • Clawbacks are required. They must be fully and timely repaid.
  • • Fees should be reduced for all but the most modest funds with larger funds taking larger reductions in ‘standard’ fees, acknowledging economies of scale.
  • • Larger investors in a fund should receive fee or carry concessions, particularly when the GP has multiple funds or follow-on funds in the market at the same time.
  • • Changes in tax law that personally impact members of a general partner should not be passed on to investors in the fund.
  • • The general partner should avoid charging transaction, monitoring fees and other fees to a deal or portfolio company.