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Everyone Complains About Private Equity Fees — But Investors Are More Likely to Walk Away Over Transparency

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When investors are choosing a private markets fund, a lack of transparency is the biggest dealbreaker. 

Fund terms, including transparency, are critical for private market investors, who often walk away from negotiations if they don’t like the fee structure — not necessarily the fee itself — or how much general partners will put into their own funds. According to Preqin’s latest report to be published on Tuesday, about 60 percent of investors have declined to participate in a fund due to proposed fund terms and conditions, including how the interests of investors and private equity firms are aligned. Twenty percent of investors said they have frequently walked away from a fund based on these concerns, according to the report.

The lack of transparency is the issue that raises the most eyebrows. In fact, investors care more about knowing what they are paying for than how much they are charged. Fifty-nine percent of investors believe this is an area where alignment of interests can be improved, up from 54 percent last year, according to the Preqin report. In comparison, only 40 percent of investors are concerned about the level of management fees and even fewer — a little over 30 percent — are concerned about the level of performance fees.

The report based the results on a recent survey of more than 300 private market investors, most of which are asset managers, family offices, and insurance companies. Twenty-nine percent of the respondents were in North America, 33 percent were in Europe, and 24 percent were in Asia. 

“The investor survey shows that terms and conditions are critical,” said RJ Joshua, author of the report and vice president of research insights at Preqin. “But it’s more [about] the transparency than the absolute level of fees.”

Private equity funds, for example, have complex fee structures that many asset owners find bewildering. Besides management fees, which are the most transparent part of total costs, investors are also responsible for travel expenses, technology costs, and legal fees incurred by managers. Of course, investors also pay carried interest, which is the performance fee. In the end, allocators aren’t always clear about what they’ve been charged, Institutional Investorpreviously reported.

Management fees have been trending down — albeit only slightly — for most asset classes, according to the Preqin report. For buyout and growth equity funds, the average management fees are close to 1.9 percent of investors’ committed capital, a little lower than the traditional 2 percent, according to the report. Carried interest, however, has remained constant at 20 percent. “Investors are happy to pay for performance,” Joshua said. “There’s certainly not fee erosion.” 

Joshua expects the war over fees between investors and partners to continue in the near future. “There’s going to be a balance of supply and demand,” he said. “Demand for private capital is still going to be strong…especially when you look at the bigger picture and the multi-asset portfolios, where recently we’ve seen high correlation between bonds and equities.” Private assets might see growing demand from investors because they can serve as better diversifiers than traditional fixed income portfolios, he said. Private debt, in particular, is attractive to investors because they have floating rates, which rise in line with interest rates. 

Besides improvement in transparency, investors are also hoping to see more partners committed to their own funds. According to the report, a quarter of partners contributed 5 percent or more to their funds. Most partners have at least committed 1 percent. “This helps to align the parties’ interests and mitigate the risk of a GP making more speculative, high-risk investments to maximize their performance-based compensation,” according to the report.

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