Private equity and real estate fund investors don't want their managers making money from fees meant to keep the lights on, and some managers are starting to react by cutting fees on existing and future funds.
Among others, TPG recently refunded $20 million in fees on its $18.8 billion flagship private equity fund, while Lone Star Funds cut its fees for its new real estate funds.
The largest private equity firms — those with funds $1 billion and larger — have cut their average management fees to 1.65% for funds being raised this year from 1.991% last year, according to a survey released in October by Preqin, a London-based alternative investment research firm.
Smaller funds also are lowering their fees. Firms sponsoring funds of less than $500 million in committed capital lowered management fees to an average of 1.98% for funds being raised this year, from 2.04% in 2008. One is Phoenix Realty Group, a real estate firm that invests in urban projects and has lowered fees on existing and new funds, said Xavier A. Gutierrez, principal and managing director in Los Angeles.
“There is a tremendous amount of pressure on firms of all sizes to lower fees,” said Mario L. Giannini, CEO of alternative investment consultant Hamilton Lane in Bala Cynwyd, Pa.
Investors are seeing that assets have come down and haven't received any distributions of profits, yet private equity fees — based largely on commitments — have not budged, he said.
“That doesn't strike many investors as fair in this environment,” Mr. Giannini said.
This combination of factors “makes investors feel as though there is an imbalance between fees and performance,” he said.
Few private equity firms are cutting fees on existing funds so far, but that should change if deal activity doesn't increase or more money isn't returned to investors. This is especially true for larger funds because “the absolute level of fees is so high,” he said.
TPG's move to cut fees was initiated by firm executives to better reflect the slower pace of investment and to enhance relations with limited partners, said sources knowledgeable about the situation.
The pressure is greater to reduce fees on new funds, including eliminating transaction fees or distributing them back to investors.
“I believe that fees will continue to come down next year as more funds come to market,” Mr. Giannini said. “I don't think it will be dramatic, but it will be meaningful, particularly since we haven't seen a cycle where (limited partners) have so much more leverage than they did a few years ago.”
Sources say the $202 billion California Public Employees' Retirement System is one investor that is heavily pushing buyout firms to slash fees, sources say. Spokesman Brad Pacheco would only say that officials at the Sacramento pension fund are reviewing the fund's relationship with its private equity managers.
The Oregon Investment Council also has been pushing for lower fees. In May, council executives released a set of principles for negotiating contracts with private equity and real estate funds. The principles include a provision to avoid distributions that give general partners more than 20% of the profits. The provision stipulates that managers should get their share of the profits only after 100% of capital, net of all fees and expenses, has been returned to the investor, except interim tax distributions.
In October, the Tigard-based council committed $400 million to Lone Star Funds after the firm cut its fees, said spokesman James Sinks. The council, which manages the $49 billion Oregon Public Employees Retirement Fund, considers the Lone Star fee deal as “setting the bar” for other general partners on fees, Mr. Sinks said.