Towers Watson has revealed an alternative fee model for private equity which includes halving the base fee and a two-tiered performance-based fee linked to staff retention, earnings growth as well as returns.
In a presentation at the Sydney event of the Towers Watson Ideas Exchange, investment consultant Dan Simpson said conventional fee structures should be challenged.
A Towers Watson private equity fee model would see the management base fee as a cost of running the business, most likely to be 1 per cent or less of invested capital, as opposed to about 2 per cent now.
Transaction fees would be done away with, and performance fees would be based on a two-tier system.
The first tier would not be linked to returns but to staff retention, and measures of the underlying investments such as earnings growth. The second tier would be returns-based but paid on the wind-up of the fund and linked to a genuine hurdle such as a margin above equities.
“With this model, if the fund outperformed equities by 5 per cent, alpha would triple,” he said. “Investors need to make this happen. We need to get smart with alternatives.”
He outlined four factors for critical success in alternatives, without all of which investors should not be investing in alternatives at all. They are:
- linking strategy to the investors’ objectives
- achieving real diversity
- being clever not complex with implementation
- reducing fee drag
He advocated a “prime manager” model in private equity where investors had a closer relationship with service providers with customised portfolios.
“A lot of alternative investments are over-engineered and over-diversified,” he said.
The iX is a series of events held around the world to debate and discuss important issues for institutional investors, and is attended by all the senior global Towers Watson investment professionals including global head of investment content, Roger Urwin, and global practice director of investment, Carl Hess. The theme for this year’s event in Sydney was making better decisions.
Head of investment for Australia, Graeme Miller, said: “I can’t think of a time where making the right decision was more important.”