Last year, the California Public Employees’ Retirement System (CalPERS)—the
nation’s largest pension fund—publicly disclosed that more
than $3 billion has been paid out over the past 17 years in performance
fees to private equity managers. During this same time period, more than
$24 billion has been made in profits.
Public pension funds, foundations, university endowments, sovereign wealth
funds, and other institutional investors have made their private equity
investing portfolios transparent as well. This gives investment advisers
incentive to take the time to research the asset class for unique characteristics
and private equity fund managers’ fees to customers.
The focus of private equity firms is providing their investors with outsized
returns while maintaining structured fees. With private equities outperforming
public equities and fixed income over the past two decades, the profit-sharing
arrangement has proven to be an effective method in providing incentives
to private equity fund managers and investors. Investors should know,
though, that future results are not guaranteed because of the success
of past performance.
Before an investor can be deemed eligible for to invest in a private equity
fund, they must qualify based on the fund’s requirements. In most
cases, a person will not qualify with less than $5 million in investible
assets, and a company will not qualify with less than $25 million in investible
assets. This can depend on the minimum commitment level set forth by the
private equity fund.
Fees for private equity funds are very high - investors are normally charged
an annual management fee by the fund manager – usually 1.5 to 2
percent. Also, there is typically a 20 percent share of profits that is
paid to the fund manager at the fund’s end date.
The distributions follow a waterfall structure. This means that in the
beginning, distributions are allocated to investors so they can get their
money back and preferred return. After reaching the hurdle rate, distributions
are typically allocated mostly to the general partner. Distributions will
be allocated 80% to investors and 20% to the general partner until the
general partner has caught up to his or her share of total profits. After
the catch-up, the remaining profits are distributed 80% to the limited
partner and 20% to the general partner.
With the long time horizon of these funds, high fees, and their illiquidity,
it is important to do some diligence to understand what you’re actually
investing in and whether it makes sense for you.