Are LPs getting their way on fund terms?

With the possible exception of hurdle rates, LPs can count numerous victories.

“I would be very surprised if in 10 years’ time much more than 50 percent of the asset class was charging on the basis of committed capital. It’s just such an anomaly within investment management as an industry. There are very good reasons for it, but I just think people will eventually say, ‘We’re not prepared to pay for that’.”

Those words belong to Richard Clarke-Jervoise, head of the private equity team at multi-family office Stonehage Fleming, from a recent interview with Private Equity International, and, while referring primarily to private equity, they easily apply to infrastructure and vast swaths of the private markets space.

He’s right, too, in the sense that fees on committed capital stick out like a private markets sore thumb, as evidenced by Probitas Partners’ 2016 institutional investor survey, where it was listed as one of their concerns about the infrastructure asset class.

Leaving aside for the moment whether Clarke-Jervoise will be proved right in 10 years’ time, his comments highlight one of the most contentious battlefields – fees – in the perennial tug of war between LPs and GPs on fund terms.

They also raise a larger question: despite all the back and forth, are fund terms, and particularly fees, evolving in the direction LPs want them to? Perhaps unsurprisingly, the answer to that depends on who you ask.

Conversations with LPs and GPs, as well as LP documentation, show that management fees have been steadily decreasing over the years and are now, on average, hovering around the 1.5 percent mark, particularly for newer vintages. The picture is less clear cut for hurdle rates and carry, though it appears carry is also gradually dropping below the 20 percent mark for newer vehicles, with hurdle rates generally holding up at around 8 percent, but with notable downward pressure.

“If core returns continue on their downward path, it’s hard to envisage most managers holding out on further fee cuts for much longer”

Notwithstanding the hurdle rate pressure, then, one could argue that LPs are mostly getting their way. But not everyone would agree with that statement.

“In private equity and infrastructure, the situation has not changed in favour of LPs,” Nick Van Winsen, head of fiduciary management at SPF Beheer, the €18 billion Dutch asset manager and pensions provider, complained in a May paper on fees published by bfinance.

“I would even say we’ve seen some deterioration in terms, such as lower hurdle rates or no hurdle rates. There is too much money chasing a few good managers. Most PE and infra funds returned so much money in the past three years, as they’ve exited investments, that a lot of LPs are underweight [in their] allocations – a lot of us are looking at the same small group of managers.”

The bfinance paper concluded that “fees have largely remained intransigent in private equity and infrastructure” and that “private market fees suffer from years of easy fundraising”. It has a point and one can legitimately wonder, given the speed with which funds are closing these days, how far LPs can really push on terms. After all, as one unnamed US pension told bfinance: “If we don’t like the fee, the next person in line will pay it.”

That is likely to be truer of flagship funds, though. In its just released 2017 survey, a majority of investors told Probitas they would like to see management fees and carry on brownfield funds drop to 1.25 percent and 10 percent or lower, respectively, on account of the compressed returns in the core infrastructure sector. If core returns continue on their downward path, it’s hard to envisage most managers holding out on further fee cuts for much longer.

Let’s also not forget about the growing importance of co-investments, club deals and other tailored structures, all of which come with their own fee reductions attached. Once you add them into the mix, it’s hard to argue that LPs are not getting what they want on fund terms – even if that’s unlikely to stop them from haggling.

Bruno Alves is senior editor of sister publication Infrastructure Investor.