We are a creative integrated marketing consultancy specialising in 4 business areas: Business Services, Financial Services, Automotive Aftermarket and Recruitment Advertising. These blogs tell of some of our experiences working in these business areas.
23 September 2013
The old formulae of 2% management fee and 20% carry is dead. Or is it? What should LPs be looking for? And how do fund managers deliver it and communicate change and why it is in everyone's best interests?
It's hard to define an LP these days. Single or multiple family office, pension fund, insurance company, bank, high-networth, gatekeepers ..... for sure. However fund managers like Blackstone have successfully evolved their business from being a fund manager, to providing parallel co-investment opportunities, to becoming LPs themselves, to providing multiple investment platforms for investors and finally to become global alternative asset advisors too. Blackstone is highly successful and others are beginning to emulate the model (Partners Group, ICG etc).
So arguably the relationship and 'contract' between fund managers and, lets call them traditional LPs, is becoming more complex and interchangeable.
Given this trend, what economic model should sophisticated LPs who understand private equity be looking for?
Arguably not one where fund managers require a 2% management fee levied yearly and the standard 8% hurdle. It's not enticing, it pays for the investment teams' lifestyle and fails to align with the long term interests of LPs.
Talking to one European fund manager recently, I noted they charge 1.5% and only once, when capital is invested. No annual fee and no taper. And why not? If they can fund aborted deals without a fee and get by for a few years building live deals to build income, they are only as good as their live portfolio and capital structures employed. They live or die by the decisions they make in real time.
So shorter investment periods linked to a fund cycle, say four or five years, with fees levied once on capital employed, seems attractive.
What else? What if investment teams put up 10% up to 20% of fund totals themselves? It would say to LPs that the team had been successful already and were very aligned. Those who couldn't or didn't, would either be newer and more of a risk or this would be reflected in the hurdle and carry.
A fund manager pursuing a short three or four year investment cycle committing up to 20% of target capital themselves and charging on capital invested only, could legitimately seek a lower hurdle and a higher carry.
You do the maths. LPs may pay more on fees back to fund managers over time, but their strategic risks are smaller, their capital allocations would be more liquid, they would enjoy better alignment and could perhaps enjoy significantly better returns in the near and long term.
Fund managers would have to offer a new deal, address the new realities on capital structures, pursue 3-5 year exit strategies and the successful ones would make more money more quickly.
Marketing is relatively easy because the messages are straight forward and plausible.
Do I see the possibility of some fund managers moving in this direction? Yes and perhaps 2:8:20 has fewer years left after all.
Chris Abraham leads AEP Advertising, a strategic marketing agency with GP, LP and corporate advisory clients active in alternative assets. Chris and his team help structure and write fundraising documentation for fund managers and placement agents.