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ANALYSIS

Limited partners hold fee-bargaining power

In a harsh capital-raising climate, ATP Private Equity Partners and TRS have different startegies on how to drive hard bargains on private equity fees.

Institutional investors are gaining concessions on private equity management fees, with a near-record number of funds on the road seeking funds resulting in a shift in bargaining power to limited partners.

The head of Danish fund ATP’s private equity arm ATP Private Equity Partners (ATP PEP), Torben Vangstrup, says that it has seen management fees drop to as low as 1.5 per cent for bigger players and remain as high as 2.5 per cent for smaller venture capital managers.

“We are in a situation today where the private equity market is not as hot as it was a few years ago,” he says.

“So we do have more opportunities to impact the terms and conditions under which we are going into these partnerships. Having said that, it is about finding a fair balance between the general partners (GPs) and limited partners (LPs). In my mind what is important is that GPs are not going to get rich from management fees, but only from outperformance.”

ATP allocated 5.5 per cent of its overall portfolio to private equity, with ATP PEP managing €7.5 billion in four funds, which range from €1 billion to €1.5 billion in size.

Vangstrup says that ATP PEP aims for an optimal uniform allocation of $65 million to each of the underlying managers, with 10 per cent of the fund kept for co-investment opportunities.

 

Better access at lower cost in Texas

Along with driving a hard bargain, large institutional investors are concentrating their allocations to managers to achieve cost benefits and better access to quality managers.

The $107-billion Teacher Retirement System of Texas (TRS) has been a high-profile case of where providing steady capital to a manager has given them both better access at lower cost than the general market.

There allocation of $6 billion to two managers, Kohlberg, Kravis Roberts (KKR) and Apollo Global Management, was on terms considerably better than the market, according to TRS chief investment officer Britt Harris.

The announcement of these ‘strategic partnerships’ were followed closely by the New jersey Division of Investment, which manages New Jersey’s $66-billion-public-pension fund, saying in December it would provide $1.8 billion to Blackstone to invest in private equity and other investments.

While big investors such as TRS have been able to gain better terms and conditions by using top-performing managers, smaller players have also seen the benefits of consolidating managers.

One fund that has looked to increase the concentration of its managers is Australian fund, SunSuper.

The $19.8-billion-superannuation fund allocates around 7 per cent of its balanced fund to private equity, and currently has committed capital to 20 private-equity managers.

“Over time we have been getting more consolidation of managers, we have identified the managers we think are worthwhile continuing with and some we are not quite as enamoured by,” Hartley says.

“We think we get a better deal on fees, terms and access when we compensate managers.”

 

Fundraiser jam

The better terms and conditions come amid a backdrop of record numbers of funds on the road trying to raise capital in many markets.

Alternative asset-research firm Preqin says that in February this year there was a ‘log jam’ of funds seeking capital, with more than 1800 private equity fundraising vehicles in the market.

This amounts to effectively three years of stock in the market, seeking an aggregate of $777.5 billion in investor capital.

The tough fundraising market has seen investors bear down on the traditional 2-per-cent management fee and the structure of the ‘carry’ part of the fee structure, which sees the general partner take 20 per cent of returns generated.

Steven Kaplan, professor of entrepreneurship and finance at the University of Chicago’s Booth School of Business, says the bargaining power has shifted to investors, with the management-fee component of private equity arrangements coming under particular scrutiny.

“There is definitely pressure from limited partners on management fees but less pressure on the carried interest where there is alignment, but there is definitely pressure on management fees,” Kaplan says.

“That is likely to continue for the next couple of years because of the huge amount of fundraising in 2006 and 2007. Those funds are coming back to market and there is less money now than there was then. While there is excess demand from the GPs for private equity, the LPs have some bargaining power.”

In addition to a focusing on fees, most managers are now required to make a hurdle rate, typically set at 8 to 10 per cent, Vangstrup says.

However, according to Preqin, management fees still remain a bone of contention for investors, with a survey of last year showing half of investors saying it was an area where alignment of interests could be improved.

In a study of fees that analysed 2400 funds over the past 20 years, Preqin showed that the mean-management fee for larger funds had only fallen marginally to 1.71 per cent, despite the recent fundraising conditions.

Cambridge Associates’ chairman and chief executive officer Sandy Urie says that managers with strong track records are still in high demand and don’t need to discount.

She notes that Cambridge predicted fees would come down after the 2008 financial crisis, but was surprised at how resilient management fees have been overall.

“For the good providers, there is a long line of capital [to which they] would love to have access,” Urie says.

It is a view shared by Cambridge managing director for Australia, Eugene Snyman, who warned that investors must think carefully about managers who are discounting to raise capital.

“Where we have seen some changes on the edges are that managers that have really struggled in a tough fundraising environment and have had to present themselves in a different way,’ Snyman says.

“But this asset class is all about manager selection and you don’t want the median of the asset class. So for managers who are struggling to raise capital and are looking to get more attractive from the fee point of view, due diligence has to be very solid to buy at the end of the day.”

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