It is perhaps not surprising that limited partners are looking to shift the balance of power in their favour – for years they have taken a back seat to elite fund managers that had the luxury of choosing the LPs in their funds, restricting commitment sizes, and in some cases charging fees and carry beyond the classic 2-and-20 structure simply because they could.
But in an environment like today’s, where liquidity is scarce and nearly every portfolio has been rocked by write-downs, LP concerns are gaining greater traction – a phenomenon that market participants have been forecasting for quite some time.
“Going forward, the LPs will be heard much more and their concerns on deal fees, size of funds will have to addressed,” David Rubenstein, the Carlyle Group’s co-founder, said earlier this year at a conference in Berlin. “For the next few years, they have the balance of power.”
Concerns over fees and fund sizes are indeed among the hot industry issues important to LPs, as PEI Media recently found when it surveyed 82 institutional investors, geographically split three-ways between North America, Europe and Asia.
While 44 percent of respondents were neutral as to whether management fees paid by LPs are “generally good value for money”, the majority of those that took a position said no, with only 17 percent responding yes.
A year or two ago, many LPs still would likely have flagged similar fee concerns, but they would have laughed if it were suggested GPs might retreat on fees – today, however, it is a tangible possibility. For example, TA Associates has reportedly cut its 25 percent carry down to 20 percent, while TPG reduced its management fees of 1 percent to 1.5 percent by one-tenth, and HgCapital lowered the management fees for its sixth fund, currently in the market to raise £2 billion, to 1.75 percent.
While these are perhaps indicators of more relief to come, investors aren’t expecting full-scale change; when asked if they thought GPs would reduce fees, the PEI LP survey respondents were split fairly equally: Aside from the 10 percent that were neutral, 46 percent did not expect any reductions while 44 percent did.
Another interesting finding is that LPs may be casting a wary eye toward placement agents. Asked if these third parties are “making a valuable contribution to the private equity fundraising process”, only 22 percent said yes, while 37 percent said no and 41 percent claimed neutrality.
Less surprising, perhaps, is that the LPs surveyed resoundingly (73 percent) said they’ll favour funds under the $1 billion mark for 2009 and 2010. The move away from mega-funds began as early as August 2007 when one advisor told PEO: “No one is doing deals and exits are slowing down. The LPs are correctly asking these guys, ‘How are you going to spend $20 billion unless there’s a massive correction in the credit markets?’”
As PEO has previously noted, in an environment where LP purse strings are pulled increasingly tight, it becomes progressively more important for GPs to acquiesce to some of their concerns. In coming months we expect fewer “neutral” investors afraid to ask for – and expect – change.
The full results of the survey – which include what 2008 and 2009 funds raised by specific managers are most admired and why – will be published in PEI Media’s forthcoming book The Definitive Guide to Private Equity Fundraising.