A fairer deal on private equity fees

October 13, 2009 - Watson Wyatt has declared that the era of excessive and misaligned fees in private equity is over. Negotiating private equity fees and terms have previously been challenging due to limited capacity among high-quality managers or "general partners" (GPs) and the restricted ability of investors or "limited partners" (LPs) to pool their bargaining power according to Watson Wyatt, a leading global consultant. In a new paper, entitled Private Equity fees and terms, the firm suggests fairer fees and terms for the asset class with the aim of encouraging debate in the LP community, with the ultimate purpose of eliminating some of the more egregious terms seen in private equity.

The paper introduces features of terms that are not yet common in the private equity community but would represent significant progress in improving alignment for LPs. It also covers additional changes that are likely to be simple to implement, such as a significant step-down in management fees after the investment period, as well as other changes that represent a more significant step-change from the status quo, such as the introduction of a hurdle rate (rather than a preferred return).

Ross Barry, Head of Portfolio Construction and Diversity at Watson Wyatt in Australia, said: “Management fees form too high a share of a GP’s compensation and are therefore the most significant factor misaligning the interests of a GP relative to those of its LPs. This misalignment is exacerbated by the manner in which performance fees are most commonly calculated in the bigger markets.”

In the paper, the firms suggests that the following changes would represent significant steps in redressing this imbalance:

• The basis upon which a manager sets its management fees must be reconsidered. For example, there is a strong case to budget for management fees on the basis of the number of investment staff and other fixed costs
• GPs should consider phasing in management fees over the investment period to reduce the significant fee drag from paying on commitments early in the life of a fund
• GPs should not generate additional fees from working with portfolio companies, for example transaction and monitoring costs. Where they do this, these fees should accrue to the fund
• All GPs should employ a European waterfall - that is, the LP receives all its capital and its preferred return before the GP receives carry

 Click here to view the entire paper. 

For more information on Australia contact

Sonja Lee
National Marketing Manager
Telephone:+612 9253 3176
sonja.lee@watsonwyatt.com.au  

About Watson Wyatt Investment Consulting
Watson Wyatt Investment Consulting, a division of Watson Wyatt, is focused on creating financial value for institutional investors through independent, best-in-class investment advice. We are specialist investment professionals who provide co-ordinated investment strategy advice based on expertise in risk assessment, strategic asset allocation, and investment manager selection. Watson Wyatt Investment Consulting provides investment advice to some of the world’s largest pension funds and institutional investors, and has over 550 associates in Europe, the Americas and Asia. 

In Australia, Watson Wyatt is the leading investment consultant to institutional investors, and advises clients with assets of over $200 billion. It has offices in Sydney and Melbourne. 

In the US investment advisory and investment consulting services are provided by Watson Wyatt Investment Consulting, Inc., which is a subsidiary of Watson Wyatt Worldwide Inc. Watson Wyatt Investment Consulting, Inc., is a registered investment adviser with the Securities and Exchange Commission. 

Watson Wyatt (NYSE, NASDAQ: WW) is the trusted business partner to the world’s leading organisations on people and financial issues. The firm’s global services include: managing the cost and effectiveness of employee benefit programs; developing attraction, retention and reward strategies; advising pension plan sponsors and other institutions on optimal investment strategies; providing strategic and financial advice to insurance and financial services companies; and delivering related technology, outsourcing and data services. Watson Wyatt has 7,700 associates in 33 countries and is located on the Web at www.watsonwyatt.com.