Key Takeaways

  • Fees in private market investments vary meaningfully both within the same fund and across different GPs.
  • Most funds have two tiers of fees. Venture capital funds and funds with higher investor demand are less likely to have multiple fee tiers, while infrastructure, private debt, and real estate funds have greater fee variation.
  • Some LPs pay consistently lower fees compared to others in the same fund. While investor size and experience partly explain this observation, unobservable characteristics such as bargaining power and negotiating skills also have a material impact on the fees LPs pay.

Watch the webinar recording here.

Summary

Motivation. 

Investments in private markets have become increasingly popular over the past two decades. However, even though management and performance fees collected by fund managers are an important aspect of private investments, they are rarely disclosed publicly. This paper aims to shed more light on the fees paid by LP investors and the extent to which they vary within private funds, across funds, and across LPs.

Methodology. 

The authors conduct their analysis on a sample of 218 U.S. public pension funds. Cashflow data from these funds is sourced at the LP-fund level from Preqin and covers US$438 billion of investments into 2,400 private capital funds from vintage year 1990 to 2019. Due to the lack of visibility into limited partnership agreements and associated side letters, the authors use this cash flow data to analyze the net-of-fee returns of different investors in the same private fund. After controlling for other potential sources of return variation, the authors are able to examine 1) how fees vary within private funds, 2) how fee structure differs across asset classes and GPs, and 3) whether some LPs consistently have access to lower fees in private markets. 

Findings. 

  • LP investors within the same private fund do not all experience the same net-of-fee returns. Instead, return performance is clustered, with 61% of private funds exhibiting two distinct tiers of net-of-fee returns. 36% of funds have only one tier of return performance.
  • Management and performance (carry) fees differ significantly for LP investors within the same fund, by 91 basis points and 5.8%, respectively. These variations are notable when compared to the traditional 2% management fee and 20% performance fee structure observed in private equity.
  • Venture capital funds have less variation in both management and performance fees (42 bps and 0.5%, respectively) compared to private equity funds (83 bps and 3.3%, respectively). Infrastructure, private debt, and real estate funds generally have greater fee variation.
  • Fee structures set by GPs depend on various static factors such as the type of asset class and dynamic factors such as investor demand. For example, venture capital funds are 33% less likely to use multiple fee tiers compared to private equity funds. Additionally, funds that have higher investor demand such as those managed by GPs with strong track records or those that are oversubscribed are also less likely to have multiple fee tiers.
  • Some LP investors consistently outperform others within the same fund by paying lower fees. Observable characteristics of these investors, such as size and experience, explain some but not all of this result. Unobservable factors such as negotiation and contracting skills are also significant in determining the level of fees paid by an LP. 
  • If all LP investors in the sample were in the lowest fee tier within their respective funds, an average of $4.30 per $100 invested or $19 billion in total would be saved in fees.

Visit ICPM Insights for all past webinar recordings.