Limited partners are getting serious about checking GPs’ calculations.
The latest investor wanting to up its game in this department is the $16.45 billion Oklahoma Teachers Retirement System. At a meeting in March the pension discussed hiring a firm to assist it with, among other things, operational due diligence and private markets reporting. Why? Because its consultant, Franklin Park, discovered four significant GP errors in the last year in its private markets programme.
The most significant in terms of the headline number was from a China‐based venture fund, which calculated and reported the fund manager’s carried interest incorrectly to the tune of $900,000. Errors of this kind do happen, we are told, and they are genuine errors rather than intentional malfeasance… but $900,000 is a lot of pensioner money.
Oklahoma TRS follows the likes of New Mexico State Investment Council and California State Teachers’ Retirement System, which hired consulting firm Colmore to track and verify their private capital programme fees and expenses to ensure they were not overpaying. California Public Employees’ Retirement System and Los Angeles County Employees Retirement Association have also undertaken exercises to understand exactly what they have paid – or should we say forgone – in fees, expenses and carry. Indeed, California law now requires public pensions to understand and publish what they pay their partners in fees and expenses (including carry).
The Institutional Limited Partners Association, meanwhile, has teamed up with Colmore to offer a service to enable members to validate fees, expenses and carried interest allocations charged by fund managers.
What to make of the fact that LPs are increasingly “tooling up” to double check GP calculations? Here are some thoughts:
- Errors go both ways; if discrepancies are the result of spreadsheet error, GPs could just as likely be putting money in LPs’ pockets rather than short-changing them. That’s no reason not to check, though.
- There is a difference between some LPs – such as CalPERS – wanting simply to know for reporting purposes how much their managers have earned and others – such as Oklahoma TRS – wanting to know whether this amount was correct.
- The presence of a decent fund auditor is normally enough. One well-established GP tells me that LP concerns about their math have been rare and quickly assuaged by the presence of a brand name audit firm and some reassurances about checks and balances. Often LPs look for further reassurance that – if they wanted to – the investor would be allowed to conduct their own audit.
- The SEC has done some thorough audits of its own, and having handed out some meaty fines for numerous fee and expense-related misdeeds has effectively encouraged most GPs to get their houses in order already.
- A case for outsourcing: one investor tells me that what they really want to see is effective separation between those responsible for fund accounting and those in the deal team. As PE firm CFOs get more involved in deals and portfolio value creation – which is a natural step – then outsourcing more of the fund accounting function becomes the logical step.
Overall, the fact investors are applying greater scrutiny to their GPs’ calculations should be welcomed; it raises the bar for GP operations in a way that will shine a light on those firms that do not make the grade.
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