So much for the interests of the principals of private equity funds being aligned with the rest of their investors.
According to Financial News, 10 of the world’s top private equity funds generated an estimated $14.6 billion in total fees over the past 15 years. Of that sum, $11.3 billion—or more than 77 percent of the total—came from management fees.
These were the fees that were originally intended to cover a firm’s costs but have now become a major source of profits. This means that if the fund — and in turn its limited partners — loses big bucks, the PE firm still gets to collect all of the management fees.
In other words: Heads, the PE fund wins; Tails, you lose. Small wonder the biggest PE firms like to continually raise new, mega-billion-dollar funds.
Is Financial News exaggerating reality? Actually, it may be understating reality. According to the report, the research used a 1 percent management fee when performing its estimated calculation.
However, in reality the typical PE fund charges 2 percent.
To conduct the research, Financial News says Oliver Gottschalg of HEC School of Management in Paris took data from the 10 US or Europe-focused general partners that raised the most money since 1995.
It did not examine hedge funds. However, according to my past research, many of the largest have also used the management fee as a profit center.
For example, in 2009 Jim Simons’ Renaissance Technologies generated more than $500 million in management fees at its three funds, mostly thanks to the Medallion Fund. However, the friends and family invested in that fund are not complaining, given the fund was up 45 percent, net of the 5 percent management fee and the 44 percent performance fee.
Louis Bacon’s Moore Capital Management racked up an estimated $450 million in revenue from its 3 percent management fee in 2009. However, his investors also aren’t protesting. Performance fees were about double the management fees as funds like Moore Global Investment was up about 21 percent while other funds were up in the mid-teens.
Several managers, however, seemingly generated more revenue from their management fees than their performance fees. For example, Bruce Kovner’s Caxton, which charges a 3 percent fee, and Ray Dalio’s Bridgewater, which charges 2 percent.
Dalio, by far, seems to have most benefitted from his management fee. In the past two years alone, he has generated around $1.4 billion in management fees as he has built his firm to become the world’s largest hedge fund firm.
In fact, when he ranked among the highest earning hedge fund managers with $400 million in 2009 (based on his share of the fees and gains on his own capital in the fund), Dalio was able to qualify despite his fund’s anemic 2 percent return because his firm’s estimated management fees of between $500 million and $550 million exceeded performance fees by roughly three-to-one.
Of course, Dalio’s limited partners only experienced a very slight gain in their portfolio.
So much for pay for performance, huh?
