GP calls out excessive fees, hits back at Bowden

Private equity investors wary of fund managers who collect too much in management fees have at least one GP firmly in their corner.

Management fees have become “excessively expensive” and “challenge the alignment of interest between GPs and LPs”, according to Stephen Catling, investment director at UK-based turnaround firm Chamonix Private Equity.

Speaking at Oxford University's Saïd Business School's Private Equity Forum, Catling said private equity management is expensive and bigger fund managers are able to get rich without the pressure of generating strong returns for their investors.

However, he did say that private equity is often costly with good reasons. He cited the need to hire the best talent, provide good operations and comply with increasing regulation, as well as being able to maintain a network of operating partners.

He added that he disagrees with the Securities and Exchange Commission's (SEC) chief inspector, Andrew Bowden, who recently told delegates at PEI's 2014 Private Fund Compliance Forum that GPs should bear the brunt of operating partner costs.

“My ability to draw upon a network of executives to introduce to portfolio companies is valued by my LPs,” he said.

Catling was also critical of the valuation practices of many GPs, calling it a “dirty little secret” that there are “perverse incentives” to value portfolio companies conservatively until exit unless the GP is fundraising, in which case, valuations are exaggerated to show increased performance.

However, this problem may be on the decline. Oxford University's Tim Jenkinson conducted research last year agreeing with Catling's statement. But to arrive at his findings, he studied the California Public Employees’ Retirement System’s (CalPERS) portfolio of 761 private equity funds going all the way back to 1990, which pre-dates the Financial Standards Accounting Board’s Statement 157 (now topic 820) on fair value measurement. Starting in late 2008, the private equity industry began marking assets to market in response to FAS-157, which left GPs a lot less wiggle-room in valuing assets with a positive bias.

Amplifying the trend of valuation discipline has been SEC registration, which went into effect in 2012 and subjected most private equity firms to potential surprise inspections. The regulator has since signaled its interest in valuation in particular and its inspectors are expected to pose questions about the consistency and technique of GPs’ valuation methods across time periods.