Tight Bomb Patterns

Photo credit: Gabi Max

This morning I had coffee with a lady from one of the emerging Asian private equity fund of funds. She told me that her team considers the Australian LP obsession with management fees quite bizarre. I am hearing this from every side at the moment.

There is a growing sense that our local LPs would rather negotiate low fees than deploy their capital in high quality private equity funds. I can’t help remembering Colonel Cathcart in the novel Catch-22, who encouraged the squadron chaplain to pray for “tight bomb patterns.” Whether or not his bombs hit a target was irrelevant to the mad Colonel, it was achieving tight patterns that mattered. Tight bomb patterns would look good on the aerial photographs and hopefully attract the attention of the top brass.

Overseas, management fees are relatively far down the mid-market LP agenda. To quote Sandra Pajarola from Partners Group*, “When investors complain about fees, they are mostly talking about huge funds. But there are only about ten of those globally.”

Australia is a strange outlier in this respect. Many of our LPs appear absolutely obsessed with management fees. It’s not uncommon for them to raise the question of fees in the very first meeting or phone call. So why is this? I have a few theories:

• Just 4 - 5 asset advisors control the majority of Australian LP capital. A strong personality or thought leader can have an influence on industry terms and conditions that would be impossible in the United States or Europe.
• Perhaps ironically, the earliest financial backers of Australian private equity were large union retirement funds. They are notoriously fee conscious.
• Our super (pension) funds are required to publish fund management expense ratios, or MERs. Unfortunately they often measure MER on drawn down, rather than committed capital. On this basis PE management fees will always appear disproportionately high and may draw the attention of the fund trustees. It takes a long time to discover whether a PE team has delivered good performance, but the management fees are evident on day one. And fund trustees are the top brass.

In the long run Australian LPs will lose this fight. The best performing managers will increasingly raise their money offshore (witness Quadrant’s latest fund) and Australian LPs will struggle to access the local top quartile.

. . . at least they will have their tight bomb patterns.

 

* Quoted in Private Equity Findings, London Business School | Coller Institute of Private Equity

Comments

[Anon]

I think you were diplomatic in talking about the local LPs. We all know that the key advisors in Australia collude like crazy on which funds to back and which fees or terms to accept.

ASIC where are you?! LOL.

[GG]

Super fund trustees are a factor. Often they have very little understanding of private equity and just react to the fee.

I have witnessed situations where the alt assets investment team wanted to commit to a PE manager but the trustees blocked it because preferential fees couldn't be negotiated.

GG.

[George]

In London the 2/20 model isn't up for serious discussion in the mid market.

However, so called "work fees" such as director fees and transaction fees certainly are on the agenda.

[DXJ]

We're raising capital for a new PE and smaller VC fund and the focus is definitely on fees. We've had protracted negotiations on the preferred return rate and carry - we went in with a sensible management fee so this was not really an issue.

Outside Fees, or what George calls 'work fees' have also been subject to negotiations. They are not averse to it but rather want full transparency. Cannot help but read between the lines that other players have used this in the past to get unfair and undisclosed benefit.

I pity a new PE or VC firm who wants to attract commitments from local LPs - very tough road even for the established players. And all these negotiations are driving the (legal) costs of delivering a new fund significantly higher than what it was a number of years ago.

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