On the record: Private markets

It pays to choose mandates 
Fees appear to be sticky in relation to private markets. High demand means private equity general partners (GPs) can stick to their traditional fee structures. Another factor is the long-standing positive track record of some of the largest and most established private equity firms. Investors may not like it, but their track record allows them to maintain fee levels where they are. 

For investors, demanding and obtaining lower fees can expose them to an asymmetric risk. If a manager who has been selected in part because of lower fees does not perform well, the decision makers who appointed them expose themselves to criticism for having chosen a low quality manager. It may also be that GPs demanding lower fees have lower quality and capacity in their teams. For these reasons, there are also added risks from working with smaller, less established private capital managers with shorter track records.

In our experience, investing through private-equity mandates can bring benefits in terms of fee reductions, compared with investing in closed-end funds. Even large investors have a hard time getting substantial discounts when investing in funds. When investing through mandates, institutions can benefit from the lower cost of marketing borne by the individual managers. Furthermore, in a mandate context, GPs will more likely compete on fees in order to attract investors.  

Cost transparency has improved in private markets but there remain certain aspects that concern us. For instance, the difference between gross and the net internal rate of return (IRR) can be as high as seven percentage points in areas such as venture capital. This is mainly because the fees are paid on committed capital, no matter how fast the money is deployed, which is a large drag on net performance. But this is also due to many other costs, which are not very transparent at all.  

When considering the case for investing in private equity, investors should be mindful that LBOs have delivered excellent results, thanks to low interest rates and buoyant equity markets, but these results may not be easy to replicate in the future. Similar to what happened in the hedge fund industry, a few years of disappointing returns have the potential to bring fees down.

More could be done   
We are generally satisfied with the level of transparency on asset management fees and costs. Explicit transaction costs, like taxes and broker commissions are very transparent. However, the reporting of implicit fees, which is the footprint of trading, leaves a lot to be desired, especially in this day and age. The information on the levels of fees paid to managers in private markets is typically all made available but you need a degree in accounting to unpick the details. Managers could do more to make that information easier to understand.

Value for money, particularly in private markets, ultimately comes down to risk-adjusted returns net of fees. We agree with the overwhelming consensus that private market fees are too high for the work involved but, like most others, we are the victims of the supply-versus-demand forces, where the best private market managers have sufficient investor demand, even at high fees. 

After a major market sell off, we typically observe a swing back in favour of investors in the fees battle. However, the sell-off induced by the spread of COVID-19 was so short lived, that investors did not manage to claw back any ground in this respect.

Performance fees are a standard part of private market mandates that we have to accept. In listed investments, we have no performance fee structures, although we like the concept in principle. A performance fee structure necessitates the use of some form of benchmark, and this clashes with our strategic decision not to set benchmarks for our managers. Setting benchmarks can lead to suboptimal decision-making, due to the need for asset managers to manage business risk in relation to the benchmark. 

Transparency has improved    
The transparency around costs and fees in private markets has significantly improved since the introduction of the standard reporting template of the Institutional Limited Partners Association (ILPA). This is a new standard but the template has been used for all newly appointed managers for a few years now.

We try to ensure that our managers provide value for money, particularly in private markets, by running a thorough due diligence in the pre-contract phase and by only investing in funds that we are entirely convinced by. After contracting, the monitoring of those managers is an important way to check them and keep them on track. Our active role during AGMs and LPAC [limited partner advisory committee] meetings helps as well.

We are reluctant about paying performance fees in listed markets, because the link to performance has to be effective and explainable to our participants. We pay performance fees sparingly, mainly to managers in non-listed investment categories, including infrastructure, real estate and private equity, where performance fees are common and unavoidable. 

Some useful ways to keep the level of performance fees limited are making co-investments and leveraging the size of our assets under management. 

Interviews by Carlo Svaluto Moreolo