Private fund managers report feeling a squeeze on fees

Private fund managers have reported feeling pressure to reduce their fees in order to secure LP commitments amid a competitive fundraising environment.

Industry participants say private fund managers have had to offer larger-than-normal fee discounts over the first half of 2023 in order to secure commitments in a timely first or second close.

"In the first half of this year, LPs seem to have had more leverage on fees," said Allan Majotra, the founder and managing partner at 5Capital Fund Placements. "We saw these GPs offer up to 25% discounts on both management fees and carried interest to select investors writing large checks to their funds—typically at a ticket size of 10% or more of the fund's target—before the first close."

Fee discounts have long been a feature of private capital fundraising, with fund managers typically giving early investors more favorable terms than the standard 2-and-20 structure, as early entrants are more exposed to blind-pool risk.

In a tougher fundraising market, GPs are more likely to agree to even steeper discounts, Majotra added.

This dynamic is affecting most managers in the market, but the very top performers are likely immune to this pressure, he noted.

The trend is not unique to private equity and has emerged across other private market funds. Making concessions In January, Sequoia Capital modified its management fee structure for two venture funds launched in 2022, Reuters reported, making concessions in order to win over investors at a time when VC deployment had slowed and tech valuations had fallen.

Fund terms had historically been GP-friendly in private equity and venture capital markets—especially for experienced managers. However, based on conversations with institutional allocators and other fund managers, Boots Dunlap, CEO of commercial real estate lender RRA Capital, said he has noticed a turning tide due to the challenging exit environment and slowing distributions.

"Many investors in PE and VC still have not received a return of capital, or their returns have underperformed expectations. So LPs' demand for those strategies is waning for the moment, which shifts the negotiation power back in the lap of LPs—at least for now," he said. 

But Dunlap said he expects that trend will flip again as soon as private market values reset and if interest rates start to decline. Spreading into real estate Some real estate fund managers that have been in the market for capital over the last 12 months have also altered management and performance fees to stay competitive, according to Christian Wenger, CEO of Clairmont Capital Group, a specialist real-estate investment firm.

The changes have resulted in GPs offering lower or even no management fees over certain stages of the fund's life cycle; lowering the share of investment profits that the fund manager can take home; and lifting the performance bar for GPs to achieve before they can claim any carried interest, Wenger said.

Mid-tier firms and emerging managers in real estate who couldn’t differentiate their offerings from the strategies that had already been offered by bulge-bracket GPs such as Blackstone, KKR and Carlyle were under the most pressure to make these concessions, Wenger said.

"What investors are looking for now—especially institutional investors—is getting their broad-based exposure through a manager like Blackstone, and that's their core exposure," Wenger said. "They then will find other differentiated strategies, like a co-GP or distressed debt model, to build a satellite approach around that core exposure." Private debt not immune  In the hot private debt market, GPs are less impacted by the fundraising slowdown and have more bargaining power than fund managers in other strategies.

However, some still report similar tensions over fees. Investors in large private debt funds have been pushing for lower management fees and more co-investment opportunities to avoid the additional costs associated with committing to a commingled fund, said Amanda Tepper, the founder of asset management consultancy Chestnut Advisory Group, citing her conversations with private debt fund managers in recent months.

External investment managers for LPs—known as outsourced chief investment officers—have also been pressing private fund advisers for fee discounts, Tepper added.

"There has been a huge push among allocators writ large to reduce fees," she said, noting that demand has softened due to an oversupply of new funds. Data playing catch up The mounting pressure on GPs to resist fee concession hasn't yet been reflected in data.

Despite the fundraising dry spell, the latest data from PitchBook indicates that by and large, private fund managers have charged consistent management fees over the past few years.

Around 50% of private market funds closed between 2020 and H1 2023 reported charging management fees below 2%, relatively unchanged from the prior three years, data from PitchBook's Q2 2023 Global Markets Fundraising Report shows.
    The good news is LPs are still attracted to the net-of-fee returns generated by private market funds and remain tolerant of paying high fees if the industry can consistently deliver stellar performance.

"While LPs often complain about the fees, they like the net returns after fees, which are 4% or 5% higher than in the public markets," said Dean Ungar, a vice president at Moody's investors service group. "That's what will keep people coming back for more."

"As long as the industry consistently maintains high after-fee returns, it will limit the fee pressure," Ungar added. "You don't want to kill the goose that's laying the golden eggs for you." 

Analysts hope the SEC's latest private capital fund disclosure rules will enhance the transparency on fees and other fund terms applied to private investment funds. This should allow LPs and other market stakeholders to gain better access to this data and to level the playing field for allocators.

Related read: PitchBook's Q2 2023 Global Private Market Fundraising Report

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This article originally appeared on PitchBook News