Fees keep going and going

A new survey of private equity funds shows lower mega-fund management fees, but longer, fee-generating investment periods.

The good news for LPs is that many management fees are slightly lower; the bad news is investment periods have effectively lengthened, drawing out the time during which LPs must pay management fees.

These are some of the results of the recently released 3rd Annual Review of Private Equity Terms & Conditions from Strategic Capital Management, a Zollikon, Switzerland-based advisory firm that surveyed all the PPMs it received between January and September of last year.

The survey found that it is still overwhelmingly the standard to use committed capital as the basis for a fund's management fee during the investment period. After the investment period is over, 44 percent of the funds surveyed used ?paid-in capital less return of principal? as the new fee basis, while 31 percent used ?net invested capital?. These next-stage fee conventions have the affect of reducing management fees by about 50 percent during the remainder of the fund's life. Only 2 percent of funds surveyed continued to use committed capital following the investment period.

While the average management fee used by funds under $1 billion in capital commitments actually increased by several dozen basis points, funds with more than $1 billion saw drops in average management fee charged from 2004 to 2005 (see charts on p. 26). However, 60 percent of funds reviewed by SCM had investment periods of five years, and a further 22 percent had investment periods of more than five years. The survey notes that a four-year investment period was standard throughout the 1990s. This means that while management fees may have dropped slightly as a percentage of capital commitments, the time period during which the fees are charged has lengthened, on average. SCM estimates that the combined effect has been a 10 percent to 15 percent increase on total management fees paid by limited partners.

Other findings of the survey include:

  • ? Management teams have not grown in pace with capital commitments
  • ? A 1 percent GP commitment has become standard, while commitments of larger percentages has become less common
  • ? A full 86 percent of European funds dictate that all paid-in capital be returned, plus 9 percent of committed capital returned, before GPs get any carry
  • ? 90 percent of funds surveyed charge a 20 percent carried interest