General Partners Gain Upper Hand Over Pension Funds As Raising Capital Becomes Easier

balancePensions & Investments released an interesting report yesterday outlining the balance of power in the private equity world between general partners and pension funds.

In the last few years, the balance of power has shifted dramatically towards GP’s, according to the report.

From Pensions & Investments:

Until the 2008 financial crisis, general partners pretty much set the rules, leaving most limited partners little say on terms, including on fees and expenses, when they committed to funds. Then fundraising got harder, and even the most popular private equity managers had to accept investors’ demands for lower fees and expenses and a greater degree of transparency.

Now, the highest-returning general partners are regaining the upper hand.

“Certainly, the pendulum has swung more toward the GP compared to 2009,” said Kevin Campbell, managing director and portfolio manager in the private markets group at fund-of-funds manager DuPont Capital Management, Wilmington, Del. The firm was spun out from the pension management division of DuPont’s pension plan in 1993.


Said DuPont’s Mr. Campbell: “I’ve seen the pendulum of power change positions several different times during the last 15 years,” where private equity fund terms are determined by the GP and sometimes they are more influenced by the LP.

Strong-performing managers that retain the same team and the same investment strategy used when they earned their strong returns have the most influence over fund terms, Mr. Campbell said. These managers also are raising a fund that is similar in size to their last fund and they have a “good investor base,” meaning investors who routinely commit to their funds, he said.


Some are increasing their negotiating clout by getting large capital commitments from sovereign wealth funds before the first close, enabling them to give other interested institutional investors a take-it-or-leave-it deal, said Stephen L. Nesbitt, chief executive officer of Marina del Rey, Calif.-based alternative investment consulting firm Cliffwater LLC.

Part of the reason GPs have power over LPs has to do with fundraising. GPs are having an easy time raising capital, which means they don’t have any incentive to negotiate terms with LPs. From P&I:

It’s easier to raise capital now; funds are raised more quickly and general partners have more influence on terms, he added.

Indeed, some private equity funds are closing very quickly, with access to much more capital than they need. Instead of holding several fund closings — giving general partners the ability to invest the capital commitments before the final close — a number of firms are having “one-and-done” closings. Because there are asset owners willing to invest on those terms, the GPs have little reason to give in to limited partners demanding changes to fund terms.

For example, Veritas Fund Management in August held a first and final close at $1.875 billion for its latest middle-market private equity fund, after just three months of fundraising. And private equity real estate manager Iron Point Partners LLC in November closed the Iron Point Real Estate Partners III LP at $750 million, well above its $450 million target.

And KPS Capital Partners LP held a first and final closing last year of its $3.5 billion KPS Special Situations Fund IV, above its $3 billion target. It was KPS’ third oversubscribed institutional private equity fund, according to a statement from the firm at the time.

Read the full report here.

Surveys: Institutional Investors Disillusioned With Hedge Funds, But Warming To Real Estate And Infrastructure

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Two separate surveys released in recent days suggest institutional investors might be growing weary of hedge funds and the associated fees and lack of transparency.

But the survey results also show that the same investors are becoming more enthused with infrastructure and real estate investments.

The dissatisfaction with hedge funds — and their fee structures — is much more pronounced in the U.S. than anywhere else. From the Boston Globe:

Hedge funds and private equity funds took a hit among US institutions and pension managers in a survey by Fidelity Investments released Monday.

The survey found that only 19 percent of American managers of pensions and other large funds believe the benefits of hedge funds and private equity funds are worth the fees they charge. That contrasted with Europe and Asia, where the vast majority — 72 percent and 91 percent, respectively — said the fees were fair.

The US responses appear to reflect growing dissatisfaction with the fees charged by hedge funds, in particular. Both hedge funds and private equity funds typically charge 2 percent upfront and keep 20 percent of the profits they generate for clients.

Derek Young, vice chairman of Pyramis Global Advisors , the institutional arm of Fidelity that conducted the survey, chalked up the US skepticism to a longer period of having worked with alternative investments.

“There’s an experience level in the US that’s significantly beyond the other regions of the world,’’ Young said.

A separate survey came to a similar conclusion. But it also indicated that, for institutional investors looking to invest in hedge funds, priorities are changing: returns are taking a back seat to lower fees, more transparency and the promise of diversification. From Chief Investment Officer:

Institutional investors are growing unsatisfied with hedge fund performance and are increasingly skeptical of the quality of future returns, according to a survey by UBS Fund Services and PricewaterhouseCoopers (PwC).

The survey of investors overseeing a collective $1.9 trillion found that only 39% were satisfied with the performance of their hedge fund managers, and only a quarter of respondents said they expected a “satisfying level of performance” in the next 12-24 months.


The report claimed this showed a change in expectations of what hedge funds are chosen to achieve. Investors no longer expect double-digit returns, but instead are content to settle for lower fees, better transparency, and low correlations with other asset classes.

Mark Porter, head of UBS Fund Services, said: “With institutional money now accounting for 80% of the hedge fund industry, they will continue seeking greater transparency over how performance is achieved and how risks are managed, leading to increased due diligence requirements for alternative managers.”

Meanwhile, the USB survey also indicated investors are looking to increase their allocations to infrastructure and real estate investments. From Chief Investment Officer:

“Despite the challenges of devising investment structures that can effectively navigate the dynamic arena of alternative markets, asset managers should remain committed to infrastructure and real assets which could drive up total assets under management in these two asset classes,” the report said.

“This new generation of alternative investments is expected to address the increasing asset and liability constraints of institutional investors and satisfy their preeminent objective of a de-correlation to more traditional asset classes.”

The report noted that despite waning enthusiasm for hedge funds, allocations aren’t likely to change for the next few years.

But alternative investments on the whole, according to the report, are expected to double by 2020.

CalPERS May Be Done With Hedge Funds, But It’s Far From Finished With Fees

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There’s been a torrent of media coverage about how CalPERS, with its decision to kick hedge funds to the curb, has also distanced itself from high-fee investment managers.

But nearly $500 million of private equity fees say otherwise, writes the New York Times’ Josh Barro:

Here’s the thing: Calpers, America’s largest public employee pension system, with $300 billion in assets under management, isn’t getting away from investment gurus altogether.

The system’s $4 billion hedge fund program is small potatoes; its main exposure to high-fee gurus is through $31 billion in private equity funds, which just like hedge funds rely on the premise that highly paid fund managers can beat the market through special insight and talent.

Calpers paid $476 million in management fees on its private equity portfolio in the fiscal year ending June 2013, equal to 1.4 percent of private equity assets, about 20 times what it would have cost Calpers to invest a similar amount in stocks and bonds. And Calpers’s commitment to private equity remains strong, guru-driven fees and all.

Ted Eliopoulos, the interim chief investment officer at Calpers, the California Public Employees’ Retirement System, made clear in a statement that the choice to exit hedge funds was specific to the asset class. He criticized hedge funds’ “complexity, cost and the lack of ability to scale at Calpers’s size.” The key word there is “scale”: Even at $4 billion, hedge funds made up just over 1 percent of the Calpers portfolio. That wasn’t enough to make a meaningful difference to the fund’s returns or diversification, and the system didn’t see good opportunities to scale up.

As of 2013, CalPERS invested 10.4 percent of its portfolio in private equity. That’s a big jump from its 6 percent PE allocation in 2006.

But, according to Josh Barro, CalPERS cut its target private equity allocation twice this year—the target allocation at the beginning of 2014 was 14 percent. Now, two downward revisions later, PE’s target allocation sits at 10 percent.


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Report: Maryland Fund Lost Billions Due To Underperformance

Wilshire Trust Universe Comparison Service
Credit: Maryland Public Policy Institute report

The Maryland State and Retirement Pension System returned 14.4 percent last fiscal year – a return that the Chief Investment Officer praised as “strong” and that doubled the fund’s expected rate of return of 7.75 percent.

But a new report from the Maryland Public Policy Institute claims that the returns weren’t good enough From the Maryland Reporter:

In a report, Jeffrey Hooke and John Walters of the Maryland Public Policy Institute say the failure to match the 17.3% return on investment made by over half the public state pension funds cost the state over $1 billion. As they have in the past, they also complained about the high fees paid to outside managers of some of the funds used by the State Retirement and Pension System, which covers 244,000 active and retired state employees and teachers and their beneficiaries

“As the table shows, the underperformance trend is not only continuing but worsening as the percentage divide widens,” said Hooke and Walters. “Part of problem may be due to the fund’s large exposure to alternative investments, such as hedge funds and private equity funds, that have tended to perform worse in recent years than traditional investments such as publicly traded stocks and bonds.”

A spokesman for the Maryland pension fund offered his response to the report:

[Spokesman] Michael Golden said the institute’s report was “flawed,” “not supported by facts,” and mischaracterized the agency’s investment performance.

“These returns have resulted in greater progress toward full funding of the system that was projected last year,” Golden said. The five-year return on investment was 11.68%, while the target for the fund is 7.7%.


Golden admitted that Maryland’s investment performance is “unimpressive” compared to other state funds.

“However, the reason for this ranking is not due to active management and fees,” Golden said. “After the financial crises of 2008-2009, the board determined that the fund had too much exposure to public equities, which historically has been one of the riskiest, most volatile asset classes, and wanted a more balanced and diversified portfolio.”

See the chart at the top of this post for a comparison between the returns of Maryland’s pension fund versus the Wilshire’s Trust Universe Comparison Service (TUCS), a widely accepted benchmark for institutional assets.