Ticking the box

Private equity’s critics rarely need encouragement when it comes to complaining about the industry’s lack of transparency, but the admission by two Californian pension funds that they weren’t sure how much they paid GPs in carried interest only provided more ammunition.

If clarity and openness are necessary for a stable financial market then the statements by the California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ Retirement System this year did little to aid the private equity industry’s hopes of attracting new investors.

“You do have to wonder how pension funds can fulfill their fiduciary responsibility to current and future retirees when they tie up retiree savings in a non-transparent asset class that they barely understand,” Eileen Appelbaum, senior economist at the Centre for Economic and Policy Research, tells Private Equity International.

“It’s clear that PE firms are making high returns, but if LPs can’t figure out their expenses and don’t know that management fee waivers reduce the payments to GPs coming out of their right pockets and simply move those payments to their left pockets, one has to wonder how they know what their returns are.”

Amid pressure in the industry for better ways to track fees LPs are paying their fund managers, the Institutional Limited Partners Association (ILPA) launched a fee transparency initiative last month. Its efforts included proposals to develop a reporting template to be used as a guide for LPs to track items, such as fees, expenses and carried interest, paid to their GPs.

“It makes good sense to standardise reporting,” Gregory Brown, finance professor at the University of North Carolina at Chapel Hill, tells PEI. “It will end up being very costly for funds to comply with a wide variety of criteria, so having a common agreed-on set of standards seems logical and ILPA should have the clout to pull it off.”

Like Appelbaum, Brown referred to the fiduciary responsibilities of the LPs.

“It is unlikely there will be simple investment decision rules that come out of more disclosure, but more information should be available because of the fiduciary responsibilities of LPs,” he says.

The initiative, which will also make recommendations on the role of third parties, such as administrators, auditors, consultants and lawyers, had contributions from multiple LPs. APG, CalPERS, DC Retirement Board, Florida State Board of Administration, NYSTRS, Texas TRS and the Washington State Investment Board were among them, as were consultants Albourne, CEM Benchmarking and TorreyCove, and fund administrator Conifer Financial Services.

“The greater the transparency, the easier it’ll be to determine the quality of fund investment,” says Jon Grabel, New Mexico Public Employees’ Retirement Association’s chief investment officer, adding that GPs are fighting the wrong battle by resisting disclosures.

They should, he says, focus more on producing results with a greater dispersion of returns.

Financial asset classes generally follow a broad pattern of starting small and opaque and making adjustments along the way to achieve relatively more transparency. Private equity now has $1.2 trillion in dry powder, according to the latest Global Private Equity Report from Bain & Co, a large enough amount for people to demand more standardisation and regulation.

“It shows that the industry is maturing and adopting to a more defined environment,” Waqar Siddique, partner and head of risk and compliance at The Abraaj Group, says.