Private equity has performed exceptionally over the last decade, but the landscape is beginning to shift as investors cut allocations and regulatory change looms. Lynn Strongin Dodds investigates.
“We want to know with clarity what exactly we are paying for and whether it is the right amount of fees. If investors have this information, it will enable them to make better decisions on investing in the products.”
Richard Moon
Despite delivering stellar returns – 300 to 500 basis points over public markets – private equity has been in the hot seat over their high fee arrangements. Over the past year, the larger US and European institutions are changing their investment models and demanding greater transparency while the Securities and Exchange Commission (SEC) is threatening greater enforcement over inappropriate payments. It is too early to determine the impact on the $3.5trn industry but as with many sector shifts, the medium sized firms are likely to bear the brunt.
As Sven Lidén, CEO of Swiss fund of funds manager Adveq puts it: “Twenty-five of the largest managers account for roughly half of the private equity market and that number has been relatively stable. I think those large managers get flooded with capital, which is bringing returns down. At the same time we see even good managers at the smaller end of the spectrum struggling to raise funds.”
Mark Calnan, global head of private equity at Towers Watson, adds: “We see a continued bifurcation of the industry. At one end of the spectrum there will be the smaller niche types of players who conduct transactions segmented by geography and sector, while at the other end there will be the large marquee names that provide solutions for the bigger asset owners who want to deploy capital across the board. Those in the middle will have to make a call as to whether they just focus on private equity or branch out and become an alternative asset management house.”
Calnan though does not expect to see the average pension fund allocation of 5% to 7% to private equity changing dramatically but predicts the larger schemes will increasingly ‘disintermediate’ and either co-invest or invest directly. While fees are the main driver, the lack of transparency, restrictive agreements and the absence of a benchmark similar to those for public equities against which to measure performance risk are also factors.
While the scrutiny over fees is not a new topic, it is one that has been reverberating across the entire alternative and active management industry since 2008. Traditionally, buyout funds have charged management fees of 2% of the total capital committed to a fund plus 20% carried interest – the manager’s share of the profits from the fund’s deals. This does not include extras such as transaction or monitoring fees, as well as costs related to raising the fund in the first place.
Adjustments were made after the financial crisis but they were short lived as fund raising returned to buoyant levels. Data from Preqin shows that 2014 was a banner year with 977 private equity funds raising a total of $486bn. This was higher than any annual amount between 2009 and 2012, and on track to match the 2013 total. The market slowed in the first half of 2015 with the amount of capital raised dipping to $41.98bn, down from $53.55bn during the same period last year, according to research from data provider Dow Jones LP Source. Analysts expect an uptick in the last six months of the year, however.
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