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Investment Companies 13 October 2011 www.numiscorp.com Marketing Communication Investment Companies 13 October 2011 Research Listed Private Equity Charles Cade +44 (0)20 7260 1327 What are the True Costs? [email protected] George Crowe Transparency has improved significantly within the listed Private Equity sector in +44 (0)20 7260 1280 recent years, and valuation methodologies have become more standardised with [email protected] the adoption of fair value accounting. This has made it much easier for investors Ewan Lovett-Turner to differentiate between listed Private Equity funds (LPEs) on the basis of their +44 (0)20 7260 1299 portfolio characteristics and balance sheet risk. However, it is still far from [email protected] straight-forward to compare the costs of LPEs in terms of fees and finance Colette Ord charges. In contrast, private equity Limited Partnerships (LPs) have relatively +44 (0)20 7260 1290 standardised fee arrangements and simple balance sheets with no debt. [email protected] In part, these complications reflect the evergreen nature of most LPEs, whereby they Sales offer exposure to a range of investment vintages. As a result, management fees are James Glass typically charged on the value of assets rather than initial commitments. Listed funds +44 (0)20 7260 1369 also face additional operating costs such as directors‟ fees and administration, and often [email protected] adopt more diverse investment strategies, including directs, co-investment and funds. Chris G00k Some have feeder fund structures, with fees charged indirectly by the manager, while +44 (0)20 7260 1378 others are self-managed and pay staff costs rather than a defined management fee. [email protected] Also, the corporate structures of LPEs are often more complicated than LPs, with Tod Davis different share classes and borrowing/over-commitment strategies. +44 (0)20 7260 1381 [email protected] The majority of LPEs utilise debt to leverage the portfolio or to facilitate an over- Katherine Miller commitment strategy. However, the nature of borrowings varies widely (including bank +44 (0)20 7260 1380 facilities, loan notes, ZDPs and convertibles), and the low return on cash at present [email protected] means that financing costs can be a significant drag on investor returns. Of course, gearing can also enhance returns and our analysis makes no allowance for returns from Website: www.numis.com/funds the assets financed or for different levels of leverage within the underlying portfolios. In the chart below, we summarise LPE expenses, including management fees and annual financing costs. This excludes performance-related fees due to the difficulties in comparing like-with-like, but includes an estimate of management fees charged on underlying PE funds. Ultimately, fees in private equity are high relative to other asset classes reflecting the specialist expertise that is required. The key is to find funds where the drag from expenses is not a major handicap to delivering attractive returns. Figure 1. Summary of Management / Financing Costs 7% 6% 5% 4% 3% 2% 1% 0% % Shareholders Funds % Shareholders LMS Better NB PE NB Oakley Electra Std Life Std F&C PE F&C Dunedin 3i Group3i Graphite Candover Pantheon Aberdeen HgCapital JZ CapitalJZ JPMorgan Conversus SVG Capital SVG PE Princess HarbourVest This marketing communication was Direct Fund of Funds prepared and approved by Numis Securities Ltd. Management fee / Staff costs Other Underlying funds Finance costs The London Stock Exchange Building Note: excludes incentive fees (carried interest). Source: Numis Securities Investment Companies Research 10 Paternoster Square London EC4M 7LT, UK For FSA purposes this marketing communication has not been prepared in accordance with legal Tel +44 (0) 20 7260 1000 requirements designed to promote the independence of investment research. Important disclosures Fax +44 (0) 20 7260 1010 relating to Numis Securities Limited are on pages 55 to 56 and include the analyst certification on page 55. For investment banking relationships, if any, with companies mentioned in the report, potential conflicts of Email [email protected] interest and additional disclosure please refer to pages 55 to 56. When applicable, disclosures regarding1 ratings maybe found at http://www.numiscorp.com/x/us/regulatory.html Registered No 2285918. Authorised and Regulated by The Financial Services Authority. A Member of the London Stock Exchange www.numiscorp.com Investment Companies 13 October 2011 Contents Fee Structure of Limited Partnerships 3 Summary of LPE Management/Advisory Fees 3 Nuances of LPE Management Fees 4 Self-Managed Funds 5 Summary of LPE Performance Fees 5 Realised or Unrealised Gains 5 Individual Investments or Portfolio Approach 5 Performance Hurdles 8 High Watermarks 9 Other Expenses Faced by LPEs 10 Total Expense Ratios 11 Our Methodology 11 Treatment of Performance-Related Fees 11 Other TER Complications 13 Financing Costs 18 Bank Debt 19 Corporate Debt 20 ZDPs 21 Convertible Bonds 22 Other Forms of Financing 23 Financing – A Summary 25 Conclusions on Fees and Financing Costs 29 Comparison with TERs of Other Investment Companies 31 Are the Costs of LPEs Justified? 32 Appendix I – LPEs: Summary of Underlying TER Data 36 Appendix II – LPEs Balance Sheet Summary 38 Appendix III – LPEs Summary of Mandates 39 Appendix IV – Fund of Funds Portfolio Comparisons 40 Appendix V – Share Price Performance of LPEs 41 Appendix VI – Summary of Management Fee Details 44 Direct LPEs 44 Fund of PE Funds 50 2 Registered No 2285918. Authorised and Regulated by The Financial Services Authority.Registered A Member No 2285918. of the London Authorised Stock and Exchange Regulated by The Financial Services Authority. A Member of the London Stock Exchange www.numiscorp.com Investment Companies 13 October 2011 Fee Structure of Limited Partnerships Standard charges of 2% plus The overall fee structure for unquoted Limited Partnership funds (LPs) investing in 20% for private equity LPs private equity is relatively standardised. They tend to charge: - 1.5-2.0% on commitments during the investment period (switching to cost of invested capital adjusted for write-downs/realisations thereafter). - 20% of realised gains subject to a hurdle of 8% pa with full catch-up. Historically, PE funds would charge 2% pa on commitments, but this has typically fallen to 1.5% pa for large cap buyout funds and 1.75% pa for mid-cap buyout funds. Smaller, more specialist buyout funds and venture capital funds still charge 2.0% pa. However, there is increasing pressure on fees given the difficult fundraising conditions at present. Some LP funds offer favourable terms or rebates to specific investors (e.g. large investors or those coming in on the first close). For instance, Permira is seeking to charge a fee of 1.5% on its new buyout fund, with a discount of 5% available for investors coming in at the first close, as well as on commitments in excess of €200m. Fund of PE Funds often Unquoted Funds of PE Funds typically have a similar fee structure, albeit at a lower charge 1% plus 10% level. They tend to charge 0.75-1.0% of committed capital, with an incentive fee of up to 10% of realised gains, usually subject to a hurdle of 8% pa. Fees for LP funds focused on Secondary investments will tend to be higher than those focused on making Primary commitments, reflecting the additional resources and expertise required. Summary of LPE Management/Advisory Fees Fee structures are more For LPEs (listed PE funds), the fee arrangements are often far more complicated, complicated for LPEs making comparisons difficult. The annual management fees for LPEs typically range from 1-2% pa, but are based on one of several measures: Net assets: equivalent to shareholders‟ funds. Within the Investment Companies universe, in general, this is the most common measure to calculate management fees. Gross assets: This represents the value of the fund's total assets including gearing. Investments: A similar measure to gross assets, although it excludes cash / cash equivalents. Undrawn commitments: Several funds charge an additional fee on undrawn commitments, often at a different rate than on invested assets. Original commitment / initial proceeds: Better Capital‟s fee is structured in a similar way to an LP, with the fee charged by the General Partner (GP) during the investment period based on the initial proceeds raised. Similarly, the majority of Oakley Capital Investment‟s fees are based on commitments to the underlying LP, while HgCapital Trust is charged fees on its commitment to Hg6 on the same basis as other LP investors. The reason why LPEs often charge fees on assets rather than initial commitments reflects the fact that they do not usually have a fixed life or defined investment period. In addition, the capital structure may change over time, with new capital issued or repurchased, and the use of leverage/over-commitment strategies. This contrasts with the relatively static structure of an LP, with defined vintages (Better Capital is an exception as it mimics the LP structure through a listed fund). 3 Registered No 2285918. Authorised and Regulated by The Financial Services Authority.Registered A Member No 2285918. of the London Authorised Stock and Exchange Regulated by The Financial Services Authority. A Member of the London Stock Exchange www.numiscorp.com Investment Companies 13 October 2011 Fees on commitments may be All else being equal, calculating management fees on the valuation of assets, rather lower for LPEs than the level of capital committed, is likely to lead to higher fees (assuming that the fund is fully invested and delivers positive returns). Offsetting this, however, many LPEs do not charge on committed capital that is not invested (or charge a lower rate). The table below summarises basic management fee arrangements for our universe of LPEs. This includes the major Private Equity vehicles traded in London, including funds listed on the London SE main market, AIM and EuroNext.
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