PEs' compensation fees under pressure

After facing problems due to limited partners (LPs) defaulting on their financial commitments, private equity (PE) funds could be in for more trouble due to increasing pressure to lower the compensation fees that LPs are charged. The new development is due to shrinking capital in the hands of major LPs, creating tough competition among PE funds to get what capital is left.

“The industry is entering a period of capital scarcity, and fees will be open to discussion as limited partners consider their options,” Philip M Bilden, Managing Director, Harbourvest Partners, an LP and PE fund of funds based out of US, said. Private equity fund of funds are investment vehicles that pool investors’ money to invest in PE funds.

“As a result, some of the PE funds are willing to do an adjustment in their compensation”, added an investment banker associated with PE practice.”It has already started globally, and it could happen here too as a majority of PE funds in India are global funds.”

KKR (Kohlberg Kravis Roberts) has already reduced its fund management charges from the standard 2 per cent to 1 per cent in its $4-billion global infrastructure fund which is currently in fund-raising mode. It has also halved its carry fee from the normal rate of 20 per cent to 10 per cent.

Carry rate is the portion of gains realised by the fund to which fund managers are entitled to, and is normally, as already stated, 20 per cent for PE funds. According to international wires, Bain Capital has even deferred management fees on two of its buyout funds to free up money and use it for follow-on investments in existing portfolio companies.

“There are fundamental flaws in the way compensation between LPs and GPs (general partners) is structured. The present management charges are too high. There needs to be an alignment of interest between LPs and the PE funds,” Vishwa Chandra, Partner, Singularity Advisors, said.

In fact, according to a lawyer with a prominent law firm, performance is yet another parameter on which negotiations are going on between LPs and PE funds.

“That is the reason why a lot of West Asia-based LPs are now asking managers to pick up equity themselves in companies their funds invest in rather than giving management fees,” the lawyer added.

According to a global survey of asset management fees by research firm Mercer, alternative investment strategies have the highest fees for each dollar of investor capital allocated, including in private equity funds of funds. The survey found that an investor might end up paying 40 per cent of the alpha (returns) in fees, in case of private equity fund of funds.

The Mercer survey went on to add that alternative investment fee structures could come under downward pressure. To some extent, investors have been disappointed with alternative asset classes and, given the fees charged for them, terms need to change between the provider and the investors.