Fees in the fine print

Private equity’s image has been taking a beating alongside Republican candidate Mitt Romney’s race to become his party’s nominee in the US election. There’ve been a plethora of stories – some defensive, some accusatory – on the former Bain Capital’s chief’s background, his firm’s track record and the fees and taxes associated with private equity. Many industry insiders are encouraging pension funds and other limited partners to speak up about the asset class’ benefits, hoping such voices would help inform the public debate swirling around private equity.

So a Financial Times article last week, whose headline declared “Private equity fee model fails to profit US pension funds”, couldn’t have come at a worse time for fund managers already feeling embattled. 

The article was based on a study by academics at Yale and Maastricht universities, whose main conclusion was that pensions had been taking a double hit in recent years in the form of higher fees and lower returns. From 2001 to 2010, US pensions on average received a 4.5 percent return on their private equity investments, while paying a 4 percent management fee as measured by funds’ invested capital, according to data from CEM Benchmarking used for the study. Compare that to the average 21 percent return and 2 percent fee charge in the years 1991 to 2000 and it’s not hard to see why the FT described the asset class as “enriching its managers” at the expense of US pension funds over the past decade. 

The Private Equity Growth Capital Council said in a response letter that in contrast to the study’s conclusion, “most industry observers believe that management fees have declined in recent years”. Indeed, PE Manager has certainly been covering a marked increase in negotiations between fund managers and investors on terms and conditions. 

One of the study’s authors noted in an email exchange with PEM that the uptick in fees during the past decade appeared to relate to fund of funds fees, but was unable to elaborate on why and noted a more detailed, follow-up paper was forthcoming. He was also unable to provide analysis on the vintage year funds captured in the data sample; should it include a large number of boom-era funds with fee step-down clauses, for example, a number of immature funds would have been recorded as having higher fees and lower performance during the past decade.

Until the rest of the academics’ findings are released, it’s hard to know exactly what this latest data on institutional investors means. It’s true that a focus on achieving better alignment of interest, and fewer relationships with fund managers, has caused a number of limited partners to consider new strategic arrangements with their private equity partners. But there’s nothing to suggest LPs feel private equity is any less important to their portfolios’ performance. On the contrary, large US pension plans, long pacesetters among institutional investors, increased their average allocation to private equity to 11.18 percent last year, up from 8.6 percent. It's hard to imagine them doing so if presented with poor performance at higher costs.