Fees and transparency: according to LPs

To read the first part of this feature, click here. 

Though GPs gladly espouse their efforts on transparency and fee structure clarity, and some LPs have the will and ability to track every penny of their private equity exposure, transparency and reporting are still seen as substantial issues among the wider LP community.

In a survey of 170 LPs and GPs for Pivot Partners' annual Reputational Risk in Private Equity Report to be published in November, 60% of LPs surveyed wanted greater disclosure on fees. The same investors rated GPs on average four out of 10 when it came to clarity of fee disclosure, whereas GPs rated themselves eight out of 10.

Similarly, the International Limited Partner Association (ILPA), which represents 300 LPs mainly from Europe and North America, launched its Fee Transparency Initiative in September, at the behest of its members. The initiative aims to produce a document with guidelines for standardisation and best practice in fee reporting and transparency, taking input from GPs, LPs and other industry players.

"Private equity has now reached a size, scale and prominence in economies around the world, where it would benefit from more standardisation," says Peter Freire, CEO at ILPA. "Private equity has a heritage of being a somewhat cottage industry. Previously LP agreements were bespoke, with GPs and LPs writing custom documents on how they wanted to structure particular transactions."

An ILPA spokesperson says that while it is true that in most LPAs the relevant information can be found by looking hard enough or by knowing where to look and having the resources to find out, it is not always as easy for LPs: "Placement agents and GPs might say it's all there if investors just ask for it, but the reality is most LPs don't find it that easy to get all the information they need. If it was, they wouldn't be requesting ILPA take this position. Many LPs are small endowments, funds or pensions, where there may be only one or two people covering this whole asset class and they don't necessarily have the ability to find these answers."

While AP6 is a prime example of a good fee-tracking procedure, the fund's modus operandi also points to why non-private-equity-exclusive funds may struggle. Without a degree of standardisation across reporting, the differences between documents from different GPs will require an – arguably unreasonable – amount of time and savvy in order to extract the relevant data and collate it in the LP's own tracking system.

As such, efforts including ILPA's Fee Transparency Initiative should be welcomed by the private equity industry. But beyond helping to ease LPs' tracking efforts, such templates need to be practical. "ILPA has put together a draft template of how to disclose fees and payments made. I've looked at it and asked a number of GPs and LPs about their thoughts, and it is so complicated that no one can understand it – it's not a workable document," says one GP's head of investor relations, who spoke on the condition of anonymity.

In response to this criticism, an ILPA spokesperson asserted that the current draft template is based on LPs' needs, and wants of GPs. Furthermore, the association has been in contact with GPs regarding reporting standards, and is taking their comments into serious consideration.

ILPA is not alone in its efforts to cultivate greater standardisation in the industry's reporting standards. European private equity association Invest Europe (formerly EVCA) is also working on improved reporting guidelines for its members.

The association previously encouraged members to follow a set of guidelines and standards set out by IPEV, but has recently developed a new set of investor reporting guidelines that also cover best practice on fees and carry. The document is expected to be issued in Invest Europe's members handbook before the end of the year and will include a worked-through example.

Setting the standard
Standardisation will help many LPs better track their private equity outlays and reduce the resources spent on tracking, but it remains unlikely that perfect standardisation will ever be achieved. Freire says he does not think the industry will ever get to a single template that encompasses all that is reported between GPs and LPs, because there are LPs that are going to need specific information relative to their context.

"But if 80% of the information between GPs and LPs is standardised, that has to help everyone across the industry," says Freire. "Looking at a document you recognise and which shares common attributes with other documents you are seeing, makes understanding the numbers and how they relate to each other much easier. From a GP's side, if you're reporting to hundreds of LPs, there are benefits to knowing you'll be reporting consistently in a very similar format to all of them.

"I don't pretend standardised reporting is a cure-all to every issue we might be wrestling with as an industry, but it can only help the communication between GPs and LPs and send a message to the public, regulators and anyone else looking at our industry that we're moving forward to create as transparent an industry as possible."

 

LONG ROAD TO TRANSPARENCY
Despite the media attention fees and reporting have been receiving this year in particular, this has been a long-standing point of debate in the industry.

Like many hot-button issues in private equity, such as ESG, greater transparency and standardisation in reporting fees and costs forms part of an evolution that occurs in all industries as they mature.

The financial crisis of 2008 brought increased scrutiny to the entire financial services sector and private equity was no exception. Where investors had perhaps previously been content to sit back and receive the strong returns private equity has enjoyed as an asset class, the downturn caused some LPs to look more closely at the value-for-money they were getting from their investments in different asset classes.

"Pre-financial crisis you had very strong financial profiles and there wasn't as much focus on the net cash as there is today," says Mounir Guen, founder and CEO of MVision. "During the financial crisis, the J-curve of deployment velocity of funds was flattened and you had lingering costs with lower return profiles. There was a real focus on net cash and cashflows, but because the spread in many cases was quite large when looking at the returns, the investors needed clarification and for this to be addressed. Coming into today's market, GPs are transparent, reporting and highly focused on net numbers – and returns, generally, are more robust."

Before the financial crisis and as far back as the inception of private equity as an asset class, the industry was generally more opaque across all aspects – not just fees reporting. The increased scrutiny and criticism of the industry's transparency and reporting standards has not developed from a vacuum.

"The current debate has its root in historical reasons," says Mads Ryum-Larsen, IK Investment Partners' head of investor relations and partner. "There have been some GPs who charged a long list of fees in addition to the management fees that are paid by LPs and, when that happens, there will be uncertainty about what is being paid. It was more common 10 years ago than it is today." Ryum-Larsen adds that part of the reason behind the change is a result of investors becoming more experienced and more powerful.

His view is shared by Annette Wilson, head of investor relations at Silverfleet Capital, who says she has seen LPs become much more demanding as the industry has matured during her 15-year career in private equity. As with topics such as ESG, where GPs have taken it upon themselves to respond to increased demand from LPs to address the matter, improvements in transparency and reporting have developed mainly as a natural evolution.

Whether the efforts will be enough remain to be seen, however, and the high-profile cases and debate in the US have seen the SEC take an increased interest in private equity's reporting standards. While no official regulation proposals have been tabled yet, not taking a progressive stance on meeting LPs' demands for transparency and reporting could result in regulatory intervention.

"The regulators are pushing in the direction of transparency and regulators have certain views," says MVision's Guen. "As private equity grows in critical mass and becomes more important, people will have different views. It is evolving, but the trend towards full transparency is there."

Both Ryum-Larsen and Wilson share the belief that regulation is not necessary and that GPs are working towards a level of transparency that will satisfy investors and regulators. "If a situation arises where one or two GPs do not want to provide investors with information, LPs have the ultimate sanction and may decide not to back them in their next fund," Wilson says.

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