Some Pension Funds Want Longer Private Equity Deals; Funds Bypassing PE Firms To Avoid Fees

flying one hundred dollar billsPrivate equity investments typically operate on a five-year timeline. But some pension funds are talking with private equity firms about longer-term deals. And at least one pension fund is cutting out the middleman and buying companies outright to avoid fees.

Reported by the Wall Street Journal:

Canada Pension Plan Investment Board is “open to conversations” with private-equity firms about partnerships to buy and hold companies for longer than the traditional five-year investment period, said Neal Costello, a London-based manager at the C$227 billion ($203 billion) pension fund.

Blackstone Group LP and Carlyle Group LP are among private-equity firms exploring how they can do longer-term deals with investors such as CPP and sovereign-wealth funds, people familiar with the firms have said.

Such deals could represent a major shift in the private-equity industry. The firms may use their own balance sheets rather than their funds to buy large companies with investors, people have said.


Large institutional investors are balking at paying expensive private-equity fund fees, and they are seeking to hold investments for longer. CPP is already buying companies outright, in addition to investing in private-equity funds and taking direct stakes alongside those funds. Earlier this year, it bought insurance company Wilton Re for $1.8 billion.

“That’s a very long-term asset,” Mr. Costello said Thursday at a conference in London organized by the British Private Equity and Venture Capital Association. “We can look at a 20-year investment period.”

Universities Superannuation Scheme, a London-based pension manager of £42 billion ($67.6 billion), would also consider longer-term deals in partnership with private-equity firms, according to Mike Powell, head of the private markets group at USS Investment Management.

“If we find good assets, we want to hold on to them as long as we can,” Mr. Powell said in an interview at the conference.

USS has already bypassed private equity and other fund managers entirely: It owns direct stakes in London’s Heathrow Airport and NATS, the U.K.’s air traffic service. Investing directly in infrastructure projects and companies is a way of avoiding paying high fees to fund managers, Mr. Powell said.

One problem that arises with a longer timeline is the issue of fees; most pension funds would balk at the additional expenses that accompany PE partnerships longer than five years. From the WSJ:

An obstacle to doing longer term deals with private-equity firms is figuring out how to pay the deal makers for such transactions, Mr. Powell said. Private-equity firms typically charge an annual fee of between 1% and 2% and keep 20% of profits when they sell a company, a model that won’t work if assets are held for many years.

“How do we remunerate them over the long term?” Mr. Powell said. “That’s up to Carlyle and Blackstone to come up with the answer.”

Ontario Municipal Employees Retirement System, a Canadian pension manager, has stopped investing in private-equity funds to avoid paying their fees, Mark Redman, the European head of its private-equity group said at the conference. The pension fund is buying companies directly instead.

The switch will benefit the pensions of the Canadian workers such as firefighters and policemen by saving them money, Mr. Redman said.

“The amount of fees that we were paying out for a fund, 2 and 20 [percentage points] and everything that goes with that, was a huge amount of value that we were losing to the fund,” Mr. Redman said. “If we could deliver top quartile returns and we weren’t hemorrhaging quite so much in terms of fees and carry that would mean that we would be able to meet the pension promise.”

Pension funds might have some leverage here — Pension360 has previously covered how PE firms want more opacity in their dealings with pension funds. The firms have been upset about the amount of private equity information disclosed by pension funds as part of public records requests.


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Some Private Equity Firms Want More Opacity In Dealings With Pension Funds

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Private equity firms are growing uncomfortable with the amount of information disclosed by pension funds about their private equity investments.

PE firms are cautioning their peers to make sure non-disclosure agreements are in place to prevent the public release of information that firms don’t want to be made public.

Stephen Hoey, chief financial and compliance officer at KPS Capital Partners, said this, according to COO Connect:

“We had correspondence with a municipal pension fund relating to the Limited Partner’s inquiry regarding the SEC’s findings from our presence exam. We objected to our correspondence with the LP of matters not relating to investment performance including notes taken by the LP representatives being submitted to reporters under the Freedom of Information Act (FOIA). It is our communications with LPs other than discussions about performance metrics that we object to being in the public domain.”

Pamela Hendrickson, chief operating officer at The Riverside Company, said PE firms should know exactly what pension funds are allowed disclose to journalists. From COO Connect:

“GPs should make sure their LP agreements and side letters are clear about what can be disclosed under a Freedom of information request. GPs must comply with any non-disclosure agreements they have with their portfolio companies and information provided under the Freedom of Information Act should be restricted to ensure that the GPs remain in compliance,” said Hendrickson.

It’s already very difficult for journalists to obtain details and data regarding the private equity investments made by pension funds.

But PE firms are worried that the SEC will crack down on fees and conflicts of interest:

The SEC has recently been questioning private equity managers about their deals and fees dating all the way back to 2007. There is speculation the US regulator could clamp down on private equity fees following its announcement back in 2013 that it would be reviewing the fees and expenses’ policies at hedge funds amid concerns that travel and entertainment costs, which should be borne by the 2% management fee, were in fact being charged to end investors.

“The SEC is taking a strong interest in fees, and this has become apparent in regulatory audits as they are heavily scrutinising the fees and expenses that we charge. Following the Bowden speech, we received a material number of calls from our Limited Partners whereby we explained our fee structure and how costs were expensed accordingly. We also pointed out that our allocation of expenses was in conformity with the LP agreements, which is the contract between the General Partner and a fund’s limited partners,” said Hoey.

COO Connect, a publication catering to investment managers, encourages PE firms to use non-disclosure agreements to prevent the public release of any information the firms want to remain confidential.


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