Bending over backwards

The flow of information between general and limited partners is essential for a transparent industry. The Institutional Limited Partner Association’s fee-reporting template has now been adopted by 160 fund managers, and several technology providers have launched tools that allow investors to drill down into the data they receive. One, eVestment, found that while generally LPs trust the high-level performance numbers provided by fund managers, more than three-quarters of them will either ‘always’ or ‘often’ recalculate manager track records when conducting due diligence.

Even after an LP has decided to commit, what’s going on in a fund may not be clear to everyone. Every LP will likely request a side letter, one funds lawyer told pfm in May. “It doesn’t help transparency as everyone is seeing different documents,” said Eamon Devlin, who leads the legal practice at MJ Hudson.

Typically, investors are privy to the terms offered to investors of a similar size, while a smaller investor is unlikely to see those offered to an investor in the tier above. This is despite the fact that, in Europe, the Alternative Investment Fund Managers Directive requires any ‘preferential treatment’ of investors to be disclosed. 

The flow of information between general and limited partners is essential for a transparent industry. The Institutional Limited Partner Association’s fee-reporting template has now been adopted by 160 fund managers, and several technology providers have launched tools that allow investors to drill down into the data they receive. One, eVestment, found that while generally LPs trust the high-level performance numbers provided by fund managers, more than three-quarters of them will either ‘always’ or ‘often’ recalculate manager track records when conducting due diligence.

Even after an LP has decided to commit, what’s going on in a fund may not be clear to everyone. Every LP will likely request a side letter, one funds lawyer told pfm in May. “It doesn’t help transparency as everyone is seeing different documents,” said Eamon Devlin, who leads the legal practice at MJ Hudson.

Typically, investors are privy to the terms offered to investors of a similar size, while a smaller investor is unlikely to see those offered to an investor in the tier above. This is despite the fact that, in Europe, the Alternative Investment Fund Managers Directive requires any ‘preferential treatment’ of investors to be disclosed.

The poor visibility for LPs is exacerbated by the increase in co-investment. GPs charge a range of fees on co-investment, even within the same funds, with prominent LPs using side letters to secure more favorable co-investment rates, according to MJ Hudson research. Similarly, discounts on fees for large LPs or those that commit early – as is the case with CVC Capital Partners’ latest fund – or multiple fee and carry options – such as in Vista Equity Partners’ latest – mean that the notion of ‘headline terms’ that can be benchmarked is difficult.

Terms of endearment

Fund terms can even change between launch and final close. Last year, Apax Partners started marketing its ninth fund with an option of deal-by-deal carry or whole-of-fund carry. By the time the fund held a final close, the firm had scrapped the deal-by-deal option. Obviously LPs in the fund were aware of the terms they received, but anyone gathering data on the fund for research or benchmarking purposes may have ended up with inaccurate data.

Finally, the increasingly widespread use of subscription credit lines as a method to delay capital calls – and improve an investment’s internal rate of return – has implications for LPs wishing to compare GPs’ historic track records. IRRs may not be a useful comparison if credit line usage is not consistent between funds.
The need for ‘transparency’ in private funds management is often misinterpreted as the need for firms to be more open with the public. But true transparency lies in the flow of information between GP and LP. If this is compromised, all the industry’s hard work in this area risks being undone.

The poor visibility for LPs is exacerbated by the increase in co-investment. GPs charge a range of fees on co-investment, even within the same funds, with prominent LPs using side letters to secure more favorable co-investment rates, according to MJ Hudson research. Similarly, discounts on fees for large LPs or those that commit early – as is the case with CVC Capital Partners’ latest fund – or multiple fee and carry options – such as in Vista Equity Partners’ latest – mean that the notion of ‘headline terms’ that can be benchmarked is difficult.