Tide turns on PE balance of power

Calpers, the giant US public pension fund, announced in September that it would endorse principles set out by the Institutional Limited Partners Association (ILPA) to promote stronger alignment of interests between private equity limited and general partners. Experts in the private equity market are touting those principles as a foundation upon which corporate governance and pricing could improve for pension fund limited partners, just as the balance of power is shifting in their favour.

ILPA was set up as a voluntary organisation to promote the interests of public and corporate pension funds, among others. The ILPA principles are essentially a collection of issues that have been on the minds of limited partners for some years but until now LPs have carried no bargaining power. The more illiquid financial environment means LPs have a little more ability to impress upon the general partners, the fund managers, their wants and desires now that fundraising is much more difficult.

David Larsen, managing director and a leader of the corporate finance consulting practice in the San Francisco office of Duff & Phelps, a corporate financial adviser, claimed that the call for transparency in fact relates to the need for limited partners to improve their own processes, concerning committee meeting planning, the use of independent third party auditors and general governance practice.

"LPs have realised they need to improve their procedures. Increased requests for our services in assisting limited partners are to look at their own policies, and to help evaluate their general partners."

The real stumbling block where LPs seek greater powers is in the allocation of transaction costs, fees and how they are split. The ILPA guidelines are seen as common principles from which everyone can work, said Larsen. Pension funds and other investors are not especially keen to collude more widely, as this could dilute their negotiating powers, and prompt allegations of acting in concert.

USS, the £26bn (€33bn) UK pension fund, now has its own in-house private equity investment team to conduct these negotiations. And Mike Powell, head of alternatives at USS, suggests the ILPA guidelines could be beneficial to its goals. "As active members of ILPA, we took part in the investor survey that formed the basis of the ILPA principles. Whilst we have not, as of yet, officially endorsed the principles, we are strongly supportive of the initiative and have been engaging with ILPA to see how we can continue to promote and wfurther improve best practice within the industry," said Powell.

Increased bargaining power is not necessarily about giving pension funds and other investors the biggest piece of the pie, but about ensuring investors get a fair return for the money they allocate, according to Mark Calnan, senior investment consultant and global head of the private equity team at Watson Wyatt.

His team has been assisting clients in negotiations between limited and general partners, as well as opening the communication channels which have made private equity seem like a somewhat cloak and dagger investment process.

"Large private equity investors with in-house teams have the knowledge and capability to do the negotiating with general partners on specific terms and fees themselves, but the reality for the majority of small to mid-sized investors is they may not have the resources to negotiate terms and they haven't historically had the quantum of capital to ensure managers will listen to them on a standalone basis," said Calnan.

Watson Wyatt has started to put clients in touch with other investors, in order to gain their feedback on key negotiating elements. The desire, said Calnan, is not to create collusion or about "hammering them down on price" but to give investors the information they need to ensure managers do not argue that they are asking for unreasonable fee terms.

"This is about creating a partnership environment, not trying to steal fees, and about asking what is a fair structure for both parties that pays the team a competitive salary and affords them the motivation to generate returns. The guidelines recognise that investors want a fair deal but that there is no ‘one size fits all' policy."

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