Private Equity More Becoming Expensive

In 2007, the private equity industry’s aggregate management fees reached US$33 billion globally, according to London-based Private Equity Intelligence, Ltd. (Preqin).

The rapid growth of private equity assets under management has pushed fees higher. In 2007, the private equity industry’s aggregate management fees reached US$33 billion globally, according to London-based Private Equity Intelligence, Ltd. (Preqin), an alternative investment research firm. This represents an increase of 83 percent from 2003’s aggregate fees of US$18 billion. Preqin indicates that these are management fees only and do not include the fund managers’ carried share of profits, fees for specific transactions or other costs to investors. Private equity funds focused on buyouts led the industry with aggregate management fees of US$13.3 billion, nearly twice as high as venture funds (US$6.8 billion). After real estate (US$5.6 billion), the remaining sectors had aggregate 2007 fees of below US$1.5 billion each. Of course, aggregate fees are higher for sectors with greater assets under management. Buyout remains the largest sector, having raised US$82 billion in the first quarter of 2008. This trend toward higher fees has not gone unnoticed by investors, Preqin says. The research firm found in a poll of 100 investors that 80 percent have declined an investment opportunity because of the fee structure and terms of the deal. The notion that “2 and 20” terms (i.e. a 2 percent management fee and the retention of 20 percent of the fund’s profits) is standard, Preqin reports, “remains a popular myth.” Instead, private equity fund terms and fees can vary significantly. It seems as though the increase in fees is at least in part the result of investor zeal. Currently, the industry has total assets under management of approximately US$2.2 trillion, according to Preqin. US$820 billion (37 percent) is “dry powder,” funds not committed to a particular investment opportunity. Yet, the money keeps coming. Investors put US$163 billion into private equity funds in the first quarter of 2008, making it the second highest fundraising quarter in the industry’s history. Demand for access to these alternative investments appears to be pushing prices higher.