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Private equity fund managers face mounting pressure on - BackBay

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									Private equity fund managers face mounting pressure on fees, according to new
data

      87 percent of institutional investors would reject a fund because of its fees
      Just a fifth – 21 percent – believe the traditional management fee of two percent
       is now acceptable
      Over one third of limited partners are looking to reduce the number of general
       partners they invest with
      Strong growth in demand anticipated for co-investment and separate accounts

PEI, the leading financial information group for alternative asset classes globally
(http://www.peimedia.com/), reveals data today demonstrating mounting pressure on
private equity fund managers over fees.

Surveying 100 leading institutional investors in private equity – or limited partners –
PEI found that 87 percent now considered high management fees and carried interest
(the percentage of returns above a certain level that are kept by a fund manager) a valid
reason to not invest in a given fund. Over a third (38 percent) considered fees and
carried interest a likely deterrent to investing regardless of the manager and his track
record.

As well as increasing scrutiny of the related fees, limited partners are also reconsidering
their private equity portfolio construction. Almost two-thirds (60 percent) of those
surveyed were unhappy with the number of funds currently invested in. Over a third (34
percent) were looking to reduce their number of relationships, while 26 percent were
looking to invest with additional fund managers.

“The data illustrates two major industry trends,” said Amanda Janis, Senior Editor at
Private Equity International. “If you are a private equity manager, then fundraising
through the recent economic crisis has – with a few notable exceptions – been a
challenging experience because capital has been scarce. This has allowed limited
partners to band together and push for lower fees and other more LP-friendly fund
terms. The two-and-20 fee structure was designed in a different era, when private equity
funds were smaller.

“For a long time LPs had been begrudgingly going along with what sometimes seemed
like egregious management fees, because the funds still generated good returns.
Nowadays two-and-20 looks to be the exception rather than the rule.”

Overall, more than two thirds of those surveyed (70 percent) felt that management fees
of 1.5 percent or less of a fund’s committed capital per annum were fair. Now, only a fifth
(21 percent) of institutional investors consider a management fee of 2 percent
acceptable.

Variable fees, “earlybird discounts” and “zombie funds”
The research also reveals strong support for structures that see fee levels reduced
dependent on the fund’s activity or the time at which a commitment is made. 90 percent
of those questioned agreed that management fees should be reduced after a fund’s
investment period has concluded.

Two-thirds (64 percent) felt that limited partners who commit capital to a fund early in its
fundraising process should benefit from fee reductions (of between 10 and 25 percent).
Some LPs suggest that no fees at all should be paid until capital-raising has closed.

Concern over fee levels may have been heightened by a challenging investment
environment, in which many funds have struggled to deploy capital raised. An
overwhelming 85 percent of survey respondents said they had had a request from at
least one fund manager for a fund extension over the last year. If GPs do not invest the
capital that has been committed to their fund within an agreed timeframe, they lose the
right to invest uncalled capital and hence cannot collect management fees on this
portion of the fund.

80 percent of institutional investors expressed some concern over “zombie funds” within
their portfolios, with a quarter (26 percent) being “very concerned”. A fund is considered
a “zombie” if its performance is so poor that the manager looks unlikely to be able to
raise a follow-on fund and the manager survives on the management fee income of the
existing fund.

“Zombie funds are often seen as the first step towards a GP winding down,” said Larry
Oberfeld, Senior Analyst at PEI. “Many firms are often able to stay open by relying on
management fees coming through from earlier deals. However, LPs who end up paying
these fees for a longer period find their investment returns are diluted in the long term.
Such issues have encouraged LPs to increase their communication with other investors
in funds in order to improve their knowledge and negotiating power.”

Funds of funds to decline, separate accounts to increase
The research demonstrates a declining interest in fund of funds investment. Of those
questioned, 20 percent currently invest via funds of funds and yet only 11 percent
considered themselves likely to do so in the future. In contrast, just 11 percent currently
utilise separate accounts (where terms and investment allocation can be negotiated
individually) but 17 percent say they are considering doing so. For co-investment,
whereby institutional investors reduce their management fee burden by investing directly
into businesses alongside a GP, the figures are 22 and 27 percent respectively.

Notes to Editors
To download a free digital copy of the Institutional Investor Sentiment Survey please
visit PEI’s website (here).

Methodology
PEI surveyed 100 prominent institutional investors across the globe between May and
June 2012.
Contacts:
Amanda Janis, Senior Editor, Private Equity International
Amanda.j@peimedia.com / +44 20 7566 4270

Larry Oberfeld, Senior Analyst, PEI:
Larry.o@peimedia.com / +44 20 7566 5467

About PEI:
PEI is the leading financial information group dedicated to the alternative asset classes
of private equity, real estate and infrastructure globally. It is an independent company
with over 110 staff based in three regional offices – London, New York, and Hong Kong
– and is wholly owned by its management and employees. PEI publishes five globally-
recognised magazines alongside five news websites, manages an extensive set of
databases dedicated to alternative assets, runs 24 market-leading conferences globally,
publishes a library of over 25 specialist books and directories and has a significant
training business.
http://www.PEIMedia.com

								
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