High private equity management charges prompt institutional players to reject new fund offerings and seek a more active role in joint deals
Ray Chan 4 November, 2014
Private equity funds in Asia are having to adjust their business model in the face of a growing backlash against high management fees and a push by big institutional investors to have a greater say on investments.
These deep-pocketed investors are increasingly knocking back fresh private equity fund offerings, preferring to strike a deal with the buyout operators to jointly commit funds on deals.
Under such arrangements, known as co-investments, the institutions or wealthy individuals take on a more active role. Management fees and bonus payments often no longer apply, reflecting the greater risk.
Institutions are also displaying a willingness to strike up partnerships with peers in favoured investment destinations abroad that have local knowledge, bypassing private equity altogether.
The total deal value of the Asia-Pacific private equity market dropped 18 per cent to US$45 billion last year, leaving it 40 per cent below its 2007 market peak, consultancy Bain & Co said.
“We are becoming more active in co-investments with private equity firms since we started our emerging market operations,” Ally Zhang, a managing director at multi-asset fund Siguler Guff, told an industry forum this month.
Shanghai-based Zhang said institutional investors in developed markets had become louder in their criticism of high fees at private equity firms. The New York-headquartered firm, with its more flexible arrangements with private equity, offers an example of the newfound assertiveness. With US$10 billion under management, the firm’s size gives it additional sway when terms are struck.
A poll by data provider Preqin found that 61 of 100 global investors with funds in private equity would not commit new funds, citing the steep management fees and a lack of transparency.
Private equity firms usually have a hurdle rate of 8 per cent, the rate of return asset managers must exceed before collecting bonus payments. As well as facing the high fees, investors in private equity – known as limited partners – typically commit to a lock-up period of five to 10 years.
Such long commitments are also helping to spur the trend for co-investments, but the flipside is that the institutional investors now need to devote more resources to these joint investments.
“Being direct investors, limited partners are required to become additional value generators, which is difficult,” said Stuart Schonberger, the managing director of CDH Investments, a Beijing-based fund with US$8 billion in assets. But the benefits were “no [management] fee and no carry [the bonus based on the returns of invested companies]”.
Moreover, Alex Wilmerding, a principal of Pantheon Capital, a fund investing in private equity funds, said it could be challenging for buyout firms to balance the interests of parties in co-investments.
However, private equity funds know they have to be responsive in a changing environment. Some of the biggest investors, including China Investment Corp, are striking up cross-border partnerships that sideline private equity. The sovereign fund has been building a relationship with Ontario Teachers’ Pension Plan in part to leverage the Canadian giant’s expertise in the property market in New York and Canada.
Beijing-based Hony Capital bought British restaurant chain Pizza Express for £900 million (HK$10.9 billion) in July, in one of the biggest deals by a Chinese private equity firm.