Allocators are paying more for alternative investments, and they can’t attribute it to rising management fee rates.
Instead, the blame goes to alternative investment managers that are passing along more of their costs to their investors, even as their management fees have been stable over the past several years, according to a new report from the Institutional Limited Partners Association, which represents investors in private markets funds.
The report, which was released Tuesday, is based on a 2021 survey of ILPA’s members, an aggregate dataset from Colmore, a Preqin affiliate, and insights from law firm K&L Gates.
Alternative investment managers typically charge a management fee of between 1.5 percent and 2 percent — that has remained stable, according to the report.
The report revealed that 25 percent of responding limited partners, or investors, have experienced private equity firms separately charge for administrative expenses like in-house legal, accounting, and software, rather than include them in the management fees they charge.
“The management fee traditionally has not been seen as the primary revenue driver for the general partner,” said Chris Hayes, senior policy counsel at ILPA. But that may be changing.
“What is the management fee for, if not to cover internal GP costs?” Hayes told Institutional Investor. If that’s not happening, then “why are LPs paying a management fee?” Only some of the report's findings are available to the public.
According to Hayes, asset owners don’t have a strong negotiating position when it comes to these fees, though.
“There is a sense that it’s very much a sellers’ market right now,” Hayes said. “Terms are very challenging for limited partners in the marketplace, particularly at the larger end, which is evidenced by the findings in our report.”
Another pain point for limited partners is the massive increase in “organizational expenses” over the years — 123 percent since 2011, the report showed.
These organizational costs cover the formation of funds. According to Hayes, limited partners have always paid the fees for general partners’ legal counsel to negotiate fund terms against them. Partners in the fund dump those fees into the organizational expense category. What has changed is that these costs have increased significantly.
“There's really no incentive for the GP to reduce their legal fund formation costs because the limited partner pays for it,” Hayes said. “The more our members negotiate, the more they are charged by the counsel, as evidenced by the increase in organizational expenses in the report.”
Even as overall expenses are increasing, protections for limited partners are on the decline. According to the report, 48 percent of respondents reported that more than half of the funds they had invested in over the past 12 months had contractually modified or reduced fiduciary duties.
In other words, general partners, particularly in North America and the Asia-Pacific region, can limit the legal recourse available for asset owners, even if the GPs prioritize their own interests ahead of the investors.
The report showed that only 25 percent of respondents said they were able to restore those duties during negotiations — at least half of the time.
“GPs are increasingly contracting away their fiduciary duties, with language that permits them to act in their sole discretion,” Hayes said. “That means they often can act in their own interest ahead of the fund.”