Private equity investors are getting a dose of the new normal as the hottest fund managers again demand general partner-friendly terms and fees that investors have not seen since the pre-crisis go-go fundraising days.
Some managers are again charging “premium carry” similar to 2007 vintage funds and are eliminating terms from their current funds that are designed to protect limited partners, such as preferred returns, also called hurdle rates, and clawbacks.
Hurdle rate clauses provide that general partners can't take their share of the profits until investors earn a specified return. Clawbacks, meanwhile, award investors some of the general partners' share of profits if the fund's losses on later investments mean the manager retained too large a portion of the carried interest.
Public pension fund investors are feeling the pinch the most. Sovereign wealth funds, endowments, foundations and high-net-worth investors are generally less sensitive to terms and transparency issues and are becoming the preferred investors, said David Fann, the New York-based president and CEO of private equity consulting firm in the New York office of TorreyCove Capital Partners LLC, San Diego.
When Advent International Corp. closed its eighth private equity fund in March at its $13 billion hard cap, the oversubscribed fund's terms had no investment hurdle, according to a memo to the system's board by Thomas Moutes, general manager of the $14 billion Los Angeles City Employees' Retirement System.
Sources said that was the first time in Advent's history it did not offer a preferred return.
Vista Equity Partners is charging investors in its latest two funds graduated carried interest. The two funds are an $8 billion target and no hard cap to invest in larger companies and a $2 billion target for smaller companies. Depending on distributions, carried interest starts at the typical 20% and moves up to 30%, according to sources and agenda materials of the $14.4 billion Arkansas Teacher Retirement System, Little Rock.
A few investors are walking away from these funds, but not many.
Some 90% of the Advent fund's committed capital came from investors in prior Advent International funds, firm executives said.
Most investors are “term takers,” said Jonathan Grabel, chief investment officer of the $13.3 billion New Mexico Public Employees Retirement Association, Santa Fe. “There's a supply-demand imbalance,” Mr. Grabel said. “There is greater demand for allocations to these funds than there is supply ... and the demand by LPs is voracious.”
In the last six months, New Mexico PERA officials have walked away from some alternative investment funds because of the terms. And it is not always economic terms that are the deal breakers, he said.