Record fundraising by private equity firms should be good news for the firms. But, according to a study by EY expected to be released today, the flood of cash is a mixed bag.
Forty percent of private equity chief financial officers surveyed by consulting firm EY reported that margins are eroding, and they’re now doing everything from cutting staff to exploring technology and outsourcing to mitigate the pressure. Forty-six percent said they are renegotiating fees with vendors, 39 percent are implementing technology solutions, and 37 percent have increased outsourcing of certain functions. A little over a quarter of firms have reduced headcount, and just under quarter have added junior people rather than making senior hires.
“The pressures facing private equity managers are well-known — fee pressure and growing expenses, to name a few,” wrote the authors of EY’s 2019 Global Private Equity Survey. “This environment is straining the economics of almost every manager,” they continued. Still, 28 percent of those surveyed said their margins had improved over the last two years.
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Last year, private equity firms raised about $681 billion in assets – and falling margins aren’t keeping them from further fundraising. In fact, asset growth was the top priority for 76 percent of respondents to the survey. According to EY, it’s also the third year in a row that the majority of firms planning to raise a fund expect that fund to be larger than its predecessor.
At the same time, firms are facing fierce competition for investors, even as most of them are increasing their private equity allocations. To appeal to a broad range of clients, firms are offering more customized services, according to the report. In particular, smaller firms, without well-known name brands, are offering separately managed accounts and single-investor funds to stand out from the competition.
In addition, private equity firms, which have long escaped investors’ ire when it comes to high costs, are also facing pressure on fees, according to the survey of 103 CFOs.
To attract new clients, 59 percent of CFOs said they have either adopted or are considering adopting a non-traditional fee structure, including expense caps and a giving investors the choice between paying a higher management fee and lower carry or vice versa.
Of those firms that have non-traditional fees, 64 percent said they offer a performance-fee only option. Fifty-six percent reported offering fee breaks based on investor commitments, while 23 percent and 18 percent offered tiered management fees and tiered carry rates, respectively.
Some private equity firms are also competing for clients by giving them fee breaks on separate accounts and single-investor funds. Sixty-four percent reported that they are providing some kind of fee cut, with 16 percent offering discounts of more than 100 basis points.