Managers ‘should not have a free lottery ticket’

Four investors exchanged frank views about various aspects of private debt fees at a recent roundtable, with hurdle rates a lively discussion point.

The need to adjust hurdle rates, why fees should not be solely returns-based, and the logic of charging differently as a fund life progresses: some of the key talking points at a recent roundtable, the full version of which we will soon publish online and in our June magazine (watch out for a bold, modern new design!).

Here are three of the most hotly debated issues:

The hurdle “fix”

The question was raised as to whether performance fees should exist at all, although, on balance, they are accepted as an effective way of countering the urge for managers relying solely on management fees to hurriedly deploy capital. “When it becomes all about deployment, that’s problematic,” pointed out Abhik Das of Golding Capital Partners.

But there was unhappiness about managers having fixed hurdles when underlying loan positions are typically floating rate. “We shouldn’t be paying performance fees to people just because the Bank of England raise interest rates,” asserted Trevor Castledine, formerly of the Local Pensions Partnership and now an independent advisor. “It’s not right, it’s just a free lottery ticket for the managers.”

Not all about returns

There is a natural correlation between returns achieved and fees paid out, but should there be other factors in the fee equation? Gabriella Kindert, a non-executive director and former head of alternative credit at NN IP, thinks so:

“Value creation is not only about the return but many other things, such as structuring, ESG considerations, the length of ramp-up time, quality of client servicing, reporting, etc, which should be reflected in the potential to charge more fees.”

The inclusion of ESG in the above list led to a discussion about whether this was reasonable – on the basis of the cost associated with thorough ESG-related due diligence – or whether ESG is now a fundamental part of the underwriting process and does not deserve to be treated separately.

Varying fees through the fund life

There was an exchange of views on when, during a fund’s life, managers add most value. One view was that the origination phase saw the maximum effort and was the most cost-intensive period and should therefore be rewarded with higher fees.

But Richard Coldwell of British Business Investments claimed “those funds that deliver excess returns [in our portfolio] have been the ones that focus on restructuring and portfolio management”.

Regardless of which phase is considered to be the most expensive/cost-intensive – and arguably deserving of higher fees – there was a consensus that LPs should at least seriously consider the relationship between the different phases of a fund and the fees that it’s appropriate to pay at each stage.

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