With PDI’s Q1 2017 Fundraising Report showing that $31.2 billion was raised by private debt funds globally in the first quarter of this year – the largest first-quarter amount since 2008 – it’s easy to assume that growing competition must be the reason for the declining fees being charged (see accompanying chart from bfinance).
However, while this is undoubtedly a factor, it’s only part of the story. Stephanie Berdik, a partner in the corporate department and a member of the private investment funds group at law firm Proskauer in Boston, Massachusetts, points to the history of private debt as a clue to the present.
She says that, in the early days of private debt, most allocations came from private equity buckets – as a result of which, private equity style management fees and carried interest were commonplace, as that’s what these investors were used to paying.
However, more recent allocations are increasingly coming from fixed income buckets. “These investors are coming to private debt for exposure to senior debt type funds – they are not looking for mezzanine or distressed – and they are looking at fee structures through a very different lens,” says Berdik.
If fixed income emigrants raise an eyebrow at private equity type fees, this should come as no surprise. After all, the economics of private debt funds vary depending on the strategy – and senior debt funds (particularly unleveraged ones) are at the lower return end of the spectrum.
With projected returns of typically around 6-8 percent, fees and carry will normally be no higher than 1 percent and 10 percent respectively (with some market observers saying they have seen management fees as low as circa 0.5 percent).
Leveraged funds, particularly those with some exposure to unitranche, might expect fees and carry to rise to 1.5 percent and 15 percent respectively, while those targeting mezzanine and distressed may still be able to charge 2 and 20, although this would be at the higher end of expectations.
As fees on individual funds get squeezed, Alex Amos, a partner at law firm Macfarlanes in London, says the diversification afforded by having a range of different strategies allows larger fund managers to mitigate the effects.
“They have all sorts of bolt-ons that boost fee revenues so they can make the model work even though fees have come down compared with five years ago,” he points out.
A longer version of this article will appear in the July/August issue of PDI.