27 May 2016

Has fund managers' income reduced?

Earlier this week, King & Wood Mallesons held its 19th Annual Private Equity Funds Seminar, during which many aspects of private fundraising were discussed, such as the state of the funds market and key terms and conditions, as well as tax, regulatory and US specific issues. One of the key headlines was an analysis of the management fees that investors pay to the manager for running the fund. For many years there has been continuing pressure from investors to ensure that fees are set at the correct level, but has this pressure resulted in a drop in average management fees if 2015 is compared to, say, 2008?

The answer produced by the King & Wood Mallesons terms and conditions survey of 2015 is no, and this conclusion is backed up by average management fee data obtained from Preqin. The table below from the KWM survey shows only very small variations in fee levels in the past seven years, and to some that may be surprising.

However, these statistics alone do not show the bigger picture as the overall level of fee income that managers now receive has reduced, even if headline management fee rates have remained static.

The data from both the KWM survey and Preqin do not take into account any "early-bird" fee discounts that managers may offer to investors in order to get them into their fund as quickly as possible, or fee discounts based on the size of an investor's commitment, with the very best discounts reserved for the largest investors. And while early-bird discounts are less prevalent in recent years than they were in 2010-2012, size discounts remain relatively common. 

Another change during this period is the marked increase of coinvestment opportunities provided on a reduced or fee-free basis. Some funds may not have the capacity to make an attractive investment, and investors are more keen than ever to fill any potential shortfall by investing alongside funds that they have made a commitment to, and not paying the same level of fees on this extra slice of investment. While this doesn't reduce the overall quantum of fees received by the manager, it does have a negative effect on their fees as a percentage of assets under management.

Lastly, perhaps the biggest change we have seen in recent years is the treatment of transaction fees. Historically, fund managers supplemented their management fee income by charging transaction fees (and other fees) to portfolio companies and retaining some or all of these fees, with the remainder being passed to fund investors. But this is now only possible for a small number of managers.

The chart above shows that in 2008, 10% of fund managers retained all transaction fees they charged, and only 38% passed on the full benefit to their investors. Fast forward to 2015 and 95% of managers now pass on the full benefit to investors. While it is not impossible to retain some of these fees - 5% of managers still managed to retain 20% of the benefit - investor pressure in this area has been intense and the dramatic change in those seven years will be no great surprise to those in the industry. The overall result of this trend, added to increased coinvestment opportunities and size based fee discounts, is that fund managers are receiving lower overall fees than they did eight or nine years ago, even if headline rates have not changed dramatically.

 

The 19th Annual Seminar will be repeated on 7 June and these issues and many more will again be discussed, so if you were unable to attend this week, please click to register your interest in attending.

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