ANALYSIS

Extracting value from managers

Three funds find effective ways to get better value from staff, co-investment and private markets.

The Danish ATP, Australian Sunsuper and the Teachers Retirement System of Texas are among the funds looking at innovative ways to extract value and interact with the managers of their private equity allocations.

Institutional investors are increasingly seeking new ways to extract value from their private equity holdings, including forays into emerging markets, direct investing and innovative investment vehicles.

One fund that has taken an innovative approach to accessing the asset class is Denmark’s ATP, which utilises an innovative incentive structure that attempts to deal with some of the pitfalls of fund-of-funds models.

The problem of fees-on-top-of-fees, where investors are paying fees to both underlying managers and the fund-of-funds manager, has been a common criticism of these types of vehicles.

In 2000 the fund took the view that it should expand its private market program and decided to launch ATP Private Equity Partners (PEP).

“If ATP had invested their entire private equity program with external fund-of-funds managers, you could say that their returns would have been impacted by another layer of fees. As we are managing our business in a very cost-effective way, this is not the case,” ATP PEP managing partner, Torben Vangstrup says.

“If they had committed to a fund-of-fund manager, they would have had to pay annual management fees in the range of 0.25 to 0.8 per cent and that will have an impact if they do so for 10 or 15 years.”

 

Staff incentive schemes

ATP PEP manages four funds for ATP, and has €7 billion under management. Funds are typically €1 billion to €1.5 billion in size. ATP has targeted a 7-per-cent allocation to private equity and currently has 5.5 per cent of its overall portfolio allocated to the asset class.

The key difference between ATP PEP and typical in-house private-equity team or a fund-of-funds manager can be found in the incentive scheme offered to staff, according to managing partner Torben Vangstrup.

“We wanted a program in place so we could incentivise people for doing a great job, but also to give us an opportunity to attract and retain the right people,” Vangstrup says.

“The incentive structure we have put in place is very much like what you see in those funds where we invest. In general, many pension funds do not want or have the capability for this type of incentive system.”

A key problem for funds looking to build out internal-asset teams is the retention of talented staff. Pension funds, which must strictly control costs, often cannot compete with the generous bonuses paid by private-equity firms in the private sector.

ATP requires all partners at ATP PEP to invest their own funds in any investment the pension fund makes.

Under the carry program, when all the capital drawn down has been returned to ATP, including an 8-to-10-per-cent-hurdle rate, further distributions are shared between ATP PEP, other general partners and ATP.

“But this split is not even close to the typical 80/20 carry split in the private-equity industry,” Vangstrup says.

While it is voluntary for non-partner staff to invest in the scheme, the entire team currently participates. Its first fund has achieved an internal rate of return net of fees of 15.8 per cent since inception.

“The beauty of the system is that you will only be rewarded if and when you have been able to create excess returns for investors,” he says.

One key difference to other private equity managers is that you will not see ATP PEP partners walking away with headline-grabbing bonuses. Total remuneration from the carry program is capped.

“If you look at a traditional buyout fund there is no limit in terms of how much they can get, when they have a homerun they can get extremely rich from such a carry system,’ he says.

“We can’t, because we are part of a pension fund, we can get rich but we can’t get very rich because the carry program is capped.”

 

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