Uncovering the Costs and Benefits of Private Equity

Private equity fees are like snowflakes: abundant, unique, and lacking in transparency.

April 13, 2016

Private equity fees are abundant in that the headline fee levels are high, especially relative to public index strategies. Private equity fee structures are unique because each Limited Partner Agreement (LPA) is closely negotiated between GPs and LPs. The result of these complex and varied negotiations is that private equity fees lack transparency. This lack of transparency is often driven by the complexity and variability of definitions of fees.

The amount and complexity of fees have received a significant amount of attention in recent months. Institutions are pushing to reduce fee levels and increase transparency. In some cases, LPs have had difficulty in calculating how much they actually pay in fees. For a large investor, such an exercise is not trivial. The complexity leaves room for unscrupulous GPs to take  advantage of their investors; in fact, the complexity can make it difficult even for conscientious GPs to adhere to their own policies and procedures. The resulting confusion can make it impossible to have a rational discussion about the real costs and benefits of investing in the asset class.

This paper will attempt to provide a greater understanding of the different conventions used by GPs and LPs in defining how GPs are to be compensated for the services they provide, as well as to answer the question of whether this compensation is generally justified. Part II, Show Me the Money, discusses the flurry of recent regulatory actions, as well as steps LPs and GPs, are taking to plow through the various issues caused by these fee structures.

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