Study: LPs stay committed, focus on fees

A new white paper jointly produced by PEI and BNY Mellon has found that the vast majority of LPs will hold steady or increase their allocations to private equity. But many have identified management fees as a term in need of better alignment.

Limited partners want more private equity, but they want it to be better private equity, according to new white paper jointly produced by PEI Media and BNY Mellon.

Countering worries that the recent economic downturn would cause institutional investors to rethink their commitments to the asset class, the study found that 79 percent of LP respondents are planning to either hold steady or increase their private equity allocations.

But according to “Private Equity Faces The Future: Candid Views From The Market”, released today, LPs are focused on fees, and particularly on terms and conditions governing the management fee, as an area in need of improvement. Fees topped the list of LP responses when asked what they would be most focused on during negotiations for future private equity partnership commitments.

General partner respondents confirmed this fee-term priority – when asked what they expected their investors to focus on during future fund negotiations, GP respondents most frequently noted fees.
In particular, LPs respondents from around the world said they would focus on how the management fee was calculated, and also on to what extent the income produced from this fee exceeded the budget needs of the private equity firm. LPs also said they would push for transaction fees to go 100 percent toward offsetting management fees.

In the wake of the crisis, LPs have more vocally criticised fund terms that seemingly create GP profit centres based on management and transaction fees, a structure that many feel misaligns the interests of GPs and LPs . Notably, the study found no instances of LPs calling for traditional carried interest levels – usually 20 percent of investment profits – to be lowered.

Some GPs interviewed for the white paper noted that an ongoing pressure on fees and fund size would have consequences for their own businesses. Some were anticipating a step down in fee income as a result of these trends. One senior partner at a large private equity firm told white paper researchers: that although he was “positive” about his firm’s outlook and the outlook for the industry, he said that his and other private equity firms might “end up having. . . a slightly smaller business. We have a fantastic platform and model, but it was scaled for a [larger] fund”. He added that if his firm’s next fund “is meaningfully smaller. . . we can continue along the same [investment] themes, but on a current income basis we are receiving much less”.