Introduction
Private fund managers are facing increased pressure to reduce fees as they seek commitments from limited partners (LPs) in a highly competitive fundraising landscape. The trend has led to larger fee discounts during the first half of 2023, impacting various segments of the private fund industry.
Fee Discounts to Secure Commitments
Private fund managers have resorted to offering substantial fee discounts to secure timely commitments from LPs, particularly during the first or second close. Some managers have provided discounts of up to 25% on management fees and carried interest, primarily targeting investors making significant contributions, often exceeding 10% of the fund’s target.
Historical Perspective
Fee discounts have been a common practice in private capital fundraising, with fund managers typically extending more favorable terms to early investors, considering their heightened exposure to blind-pool risk. In a challenging fundraising environment, GPs are increasingly willing to offer steeper discounts, although top-performing managers may be less affected.
Expanding Beyond Private Equity
The trend of fee concessions extends beyond private equity and encompasses various private market funds. Sequoia Capital, for instance, adjusted its management fee structure for venture funds in response to challenging market conditions.
Impact on Real Estate
Real estate fund managers seeking capital in the past year have also adjusted their fee structures to remain competitive. These changes include lower or even waived management fees at specific stages of a fund’s life cycle, reduced profit-sharing for fund managers, and heightened performance expectations for GPs to qualify for carried interest.
Challenges for Mid-Tier Real Estate Firms
Mid-tier and emerging real estate managers have faced particular pressure to make fee concessions when their offerings failed to differentiate themselves from those of major players like Blackstone, KKR, and Carlyle. Investors now seek broad-based exposure through established managers and explore differentiated strategies as complementary options.
Private Debt Market Dynamics
In the private debt market, GPs have encountered less fundraising slowdown and maintain stronger bargaining power than managers in other strategies. However, similar fee-related tensions persist. Investors in large private debt funds have advocated for lower management fees and increased co-investment opportunities to avoid costs associated with commingled funds.
Pressure from External Investment Managers
External investment managers for LPs, often referred to as outsourced chief investment officers, have also exerted pressure on private fund advisers to offer fee discounts. The market has seen a significant push to reduce fees, particularly due to an oversupply of new funds.
Data Trends
Despite fee pressure, Pitch Book’s data shows that private fund managers have largely maintained consistent management fees over recent years. Approximately 50% of private market funds closed between 2020 and H1 2023 reported management fees below 2%, a trend relatively unchanged from the preceding three years.
LPs’ Focus on Net Returns
LPs continue to be attracted to the net-of-fee returns generated by private market funds, which typically exceed those of public markets by 4% to 5%. This has allowed the industry to maintain fee levels as long as strong after-fee performance is sustained.
Regulatory Outlook
Analysts are optimistic that the SEC’s latest private capital fund disclosure rules will enhance transparency regarding fees and fund terms for private investment funds. This increased transparency aims to provide LPs and other stakeholders with improved access to data, promoting fairness and informed decision-making in the industry.