Private equity industry has been under pressure in recent years. One of the key focus points has been the fee structure the firms use, but Preqin’s latest research shows firms have been slow to change. Most private equity firms still hang on to the old charging systems.
The Traditional Fee Structure
According to Preqin’s 2015 Private Equity Fund Terms Advisor report showed the continued pressure to reduce fees has not yet had an impact. The research found that majority of private equity funds continue to charge the traditional industry standard of 20% performance fee and 2% annual management fee.
When it comes to performance fees, there are some differences in terms of fund types. Whilst 85% of fund managers running commingled funds had a 20% performance fee, only 48% of separate accounts imposed this fee on investors. In addition, nearly half of fund managers avoid charging performance fee on co-investments.
In terms of management fees, a clear majority of new commingled buyout funds (launched in 2014-2015) still have an annual management charge of 2% or more, despite investor pressure to reduce it. Private equity separate accounts, on the other hand, charged 1.15% on average for management fees. 42% of these fund managers will also reduce or remove the fees after the initial investment phase.
But the industry has been continuously challenged to change its fees. Pension fund representatives recently wrote to the Securities and Exchange Commission in the US to challenge private equity’s fee structures. Even the report found many investors raising concerns over fees. Concerns have also increased quite significantly in recent months. In 2014, 28% of investors in the same study said performance fees and the structure of fees is concerning, with this year’s figure rising to 32%.
Yet, Preqin’s analysis shows some change is taking place. Selina Sy, senior manager at Preqin, stated, “Far fewer investors are concerned about the level of management fees at present, and at the same time, the proportion of investors that believe their interests are aligned with those of managers has risen significantly.”
In fact, the report shows a drastic drop in how important investors think management fees are. In 2013, 59% said management fees require improvements, but only 40% feel the same way in 2015.
New Ways of Accessing Funds
Furthermore, the report found that investors are increasingly interested in accessing private equity funds through non-traditional channels. Co-investments, for example, have clearly increased in favourability and these could potentially change the way fund managers charge investors.
This also led Preqin’s Sy to conclude, “General partners that adapt to the evolving fundraising environment will better meet the needs of limited partners and create long-term, mutually beneficial LP-GP relationships”.
While funds have been slow to respond in terms of the fees for the traditional investment channels, the new alternative routes have influenced firms’ fee approach. Big firms have begun looking into fees, even if change in actual structures hasn’t taken place yet. It remains to be seen whether the traditional routes will experience some changes in the coming months and whether investor pressure continues as strong.