LPs may not like it, but managers able to command high fees are top performers, according to a study from the National Bureau of Economic Research.
The study showed no evidence that high-fee funds “underperform on a net-of-fee basis” and that management fees and carried interest are generally unrelated to “net-of-fee cash flow performance”.
This result means that, relative to lower fee funds, more expensive private equity funds earn suffciently higher gross returns to offset their higher fees, concluded the study's authors, David Robinson of Duke University and Berk Sensoy of Ohio State University.
The study, of 837 buyout and venture capital funds from 1984 to 2010, examined the relationship between fund terms and performance.
To support the findings the researchers also examined GP's own personal investment into their funds, known within the industry as “skin in the game”. “We find no evidence that funds with low GP ownership underperform, despite concerns that managers of such funds are insufficiently bonded to the fund,” the study said. “In fact, for buyout funds the opposite is true: low-ownership buyout funds outperform.”
The study said this finding was consistent with the view that high-ability GPs prefer to diversify their personal portfolios.
On the subject of carried interest, the study found “some evidence” that buyout funds with high carried interest arrangements outperform. The study noted the opposite was true for high-carry venture capital funds.
LPs may however take warning in a separate finding that showed GPs receiving fees on invested capital tend to exit investments more slowly, but will move to exit immediately after they become eligible to receive carry. This suggests that GPs are able to “game the contractual provisions that are partially there to protect the LP’s return”. The findings echo a recent study by secondaries advisor Landmark Partners that discovered the way hurdle rates work may compel GPs to push for exits in a way that is not in the best interests of the fund.