Not such a drag

One common argument against publicly-listed private equity vehicles is that it only serves to add an extra layer of cost, thus ultimately damaging net returns.

But a recent paper by Sydney-based Barwon Investment Partners attempts to dispel this notion – by showing that in many cases, investing via listed vehicles is actually more fee-efficient than investing via a traditional unlisted limited partnership.

Barwon starts with the caveat that this comparison is far from straightforward, not least because there are lots of different fee models out there. (This is actually part of the problem, it suggests, because it makes it very difficult for LPs to do a like-for-like comparison.)

For unlisted funds, trying to calculate the total expense ratio (TER) – which looks at management, performance and all other fees relative to net asset value – is particularly complicated, since the basis on which GPs calculate fees can vary hugely. Significantly, funds can charge management fees based only on committed capital, or only on invested capital, or somewhere between the two.

But for the purposes of this comparison, Barwon made some fairly uncontroversial assumptions: a management fee equivalent to 2 percent of committed capital for the first five years (and then of invested capital afterwards); a carried interest rate of 20 percent; a hurdle rate of 8 percent; and a 100 percent post-hurdle catch-up. More debatably, it assumes an effective rate for monitoring, transaction and other fees of 0 percent, based on LPs receiving a full rebate (which seems to be the direction of travel, but probably isn’t the norm yet).

It then calculated respective cashflows, on the further assumption that investments would be held for about five years and yield a 2x gross return.

Barwon splits the listed private equity market into four categories: ‘internally managed’ funds that invest in the manager’s own funds or directly (like Kohlberg Kravis Roberts, 3i and Onex); externally-managed funds that invest directly (like Electra Private Equity); externally-managed feeder funds (like those attached to HgCapital and Dunedin), and listed funds of funds (like Pantheon International Participations and HarbourVest Global Private Equity).

Barwon points out that the first category can be particularly fee-efficient, because the likes of KKR and Onex typically manage a lot of third-party LP capital too – and the money they derive in fees and carry from those relationships offsets the fees paid at the listed vehicle level.

However, it also found that investors in funds in the second category also end up paying a lower rate – a TER of roughly 5.3 percent p.a., as opposed to 6.3 percent for unlisted funds – primarily because the latter will generally charge fees based on committed but uninvested capital for the first five years, whereas the listed vehicle will charge fees based on net asset value.

As for the other two categories, Barwon concluded that the TER outcomes are more or less the same as a traditional LP (there is an additional layer attributable to the listing, but it’s fairly minimal). But they do have one important advantage: investors are buying a “ready-baked portfolio”, as Barwon puts it, so they don’t have the fee drag associated with the ramp-up period. That means investors get similar returns but in a shorter timeframe – so their IRRs are normally better.

All told: more grist to the mill for those who think more investors should be looking to access the asset class via listed structures.