The era of LP power is in full swing, and the Oregon Investment Council (Oregon) appears to be leading the way in wringing certain concessions from private equity firms before it makes commitments to their funds.
Earlier this year, Oregon created a set of voluntary principles to follow when considering making an investment with a private equity firm. The principles include demands such as lower fees, holding back carry until investors are paid back 100 percent and giving investors the power to dissolve funds under certain conditions.
Oregon used its new guidance recently to bargain with one of the biggest firms in the industry, Lone Star, which is trying to raise $20 billion across two funds for investments in distressed real estate assets and financial institutions.
Lone Star agreed to lower its management fee, even though the fee was already well below 2 percent. It also conceded other changes suggested by Oregon, though the nature of these has not been disclosed.
In exchange for its cooperation, Lone Star was rewarded with an immediate $400 million commitment from Oregon. The pension also verbally pledged to commit another $400 million to the firm depending on the fund's early performance.
Similar negotiations have been taking place between Oregon and Fisher Lynch Capital, which set up a fund into which only Oregon and the Washington State Investment Board invest. Fisher Lynch is seeking $500 million from Oregon.
Oregon has negotiated with Fisher Lynch using its principles. Washington State, which made a recommended commitment to the fund, has not yet finalised its commitment. Fisher Lynch refused to comment about the situation.
Another huge pension, the California Public Employees' Retirement System, has announced that it will be negotiating for lower fees, including using more of the transaction fee to offset the management fee.
The changes that have taken place in the US so far may be only the beginning of a shift that will – at least for a while – force private equity firms to play by new rules, written by those that hold the purse strings.
LPs are capable of backing away from private equity investing, as demonstrated by some pensions that have ground their programmes to a halt this year, including the Pennsylvania Public School Employees' Retirement System (PSERS) and the Pennsylvania State Employees' Retirement System (PA SERS). PA SERS has yet to make a private equity commitment this year, while PSERS made its first private equity-related investment in October, committing $250 million to Sankaty Middle Market Opportunities Fund, which invests in mid-market debt.
Other LP leaders have questioned the very structure of the private equity model and whether it is still viable and fair to investors.
As we report in Asset Class this month (see page 50), Leo de Bever, head of the C$70 billion ($68 billion; €46 billion) Alberta Investment Management Corporation, is altering the way the system invests in private equity to a direct investment model. The system had been hiring external managers for its private equity investments, but that will change as de Bever begins hiring an investment team to find managers and make the investments itself.
Part of the reason Alberta is moving to direct investments is private equity firms' fee structure, which de Bever says can take away 7 or 8 percent of the expected return on investment. Also, many external managers for the past few years did not make smart investment choices, he says.
In the UK, LPs' thoughts appear to be turning in the same direction. At the British Venture Capital Association summit in London in October, Wellcome Trust chief investment officer Danny Truell called for a “Darwinian evolution” in which fund models must be re-examined, deal fees abolished or reduced and investment theses altered.
“If our private equity firms won't do it for us, we'll do it ourselves,” he said, referring to the institutional investor's 25-strong in-house investment team.
Truell also recorded displeasure over transaction fees. “We are quite happy to pay people for results,” he said, but added that deal fees should have lesser prominence.
Dominique Senequier, founder and chief executive of Paris-based funds of funds and secondaries manager AXA Private Equity, noted how important it is that GPs take their investors' views into consideration as private equity has “no future without LPs”.
It is notable how LPs increasingly seem to be talking with the same voice. Is it evolution – as Truell suggests – or is it revolution?