Let's be clear

More flexibility in fund terms may suit LPs and GPs, but threaten to bog down transparency efforts.

A lot of effort has been made to increase transparency in private funds management, especially the flow of information between general and limited partners. For example, in 2016, the Institutional Limited Partner Association launched the first industry standard template for reporting fees, which has now been adopted by 160 fund managers.

Several technology providers have launched tools that enhance GP-LP communications and allow investors to drill down into the data they are provided. One, eVestment, found that while generally LPs trust the high-level performance numbers provided by fund managers, more than three-quarters of them will either “always” or “often” recalculate manager track records when conducting due diligence.

In a recent Monday Monitor we discussed how side letters were muddying the waters when it came to transparency in fundraising. A GP should expect every LP to request a side letter, one funds lawyer told pfm at the time. “It doesn’t help transparency as everyone is seeing different documents,” said Eamon Devlin, who leads the legal practice at MJ Hudson.

Typically, investors are privy to the terms offered to investors of a similar size, while a smaller investor is unlikely to see those offered to an investor in the tier above. This is despite the fact that in Europe the Alternative Investment Fund Managers Directive requires any “preferential treatment” of investors to be disclosed.

This poor visibility among LPs is being exacerbated by the increase in co-investment. GPs charge a range of fees on co-investment, even within the same funds, with prominent LPs using side letters to secure more favourable co-investment rates, according to research from MJ Hudson. Similarly, discounts on management fees for large LPs or those that commit early in the raise – as is the case with CVC Capital Partners’ latest fund– and the multiple fee and carry options – in Vista Equity Partners’ latest – mean that the notion of “headline terms” that can be benchmarked becomes much more difficult.

Fund terms can even change between launch and final close. Last year, Apax Partners started marketing its ninth fund with an option of deal-by-deal carry or whole-of-fund carry. By the time the fund held a final close, the firm had scrapped the deal-by-deal option. Obviously LPs in the fund were aware of the terms they received, but anyone gathering data on the fund for research or benchmarking purposes may have ended up with inaccurate data.

Finally, the increasingly widespread use of subscription credit lines as a method to delay capital calls – and hence improve an investment’s IRR – has implications for LPs wishing to compare GPs’ historic track records. IRRs may not be a useful comparison if credit line usage is not consistent between funds.

The need for ‘transparency’ in private funds management is often misinterpreted as a need for firms to be more open with the public. But true transparency lies in the flow of information between GP and LP. If this becomes compromised, the industry’s progress risks being undone.