Survey: LPs get tough on management fees

A significant majority of limited partners are now willing to reject a potential fund investment because the proposed fees are too high, according to new research by sister publication Private Equity International. 

A large majority (87 percent) of the prominent institutional investors who responded to the PEI survey said high management fees and carried interest constituted a valid reason not to invest in a given fund.

Even strong managers with an impeccable track record are not immune to this pressure: 38 percent of LPs said fees and carry would act as a likely deterrent to investing regardless of who the manager was. 

Around 80 percent of respondents argued that the traditional 2 percent management fee was no longer acceptable in the current climate. Instead, the general preference was for a fee of 1.5 percent or lower; some 70 percent of respondents suggested this was a fair level. 

“For a long time LPs have been grudgingly going along with what sometimes seemed like egregious management fees, because the funds still generated good returns,” said PEI's Amanda Janis. “Nowadays two-and-20 looks to be the exception rather than the rule.” 

The research also revealed widespread support for structures which involve flexible fee levels. The survey found 64 percent of respondents felt LPs who commit to a fund early in the fundraising process should benefit from fee reductions, potentially of between 10 and 25 percent – something increasingly offered by firms eager to get to a first close in a competitive environment. 

Equally, 90 percent of respondents said fees should be reduced after a fund’s investment period has concluded. With most LPs having received requests for fund extensions lately, and with concerns over zombie funds still rife, this is clearly an issue that is particularly salient at the moment.

One consequence of fee concerns is that co-investments and separate account arrangements – both of which typically reduce the fee burden on LPs – are becoming increasingly popular. Although only 11 percent of respondents said they currently utilised separate accounts, a further 17 percent were considering doing so; while for co-investments, 22 percent currently do it, but a further 27 percent are actively considering it. On the flipside, it may be bad news for funds of funds: the survey found 20 percent of LPs currently invest via funds of funds, but only 11 percent consider themselves likely to do so in the future.

The data also showed LPs are taking an increasingly active approach to portfolio management: 60 percent said they were unhappy with their current portfolio, with 34 percent looking to cut their number of managers and 26 percent looking to boost their number of relationships.