Private Equity Management Fees Fall to Lowest Level Since Records Began

Management fees on private equity buyout funds have fallen to their lowest levels since tracking began in 2005.¹ This decline is a direct response to a challenging fundraising environment, as fund managers strive to attract investors amid increased economic uncertainty and limited exit opportunities.¹ The pressure on fundraising has led to concessions on fees and terms, reshaping the dynamics between private equity firms and their investors.

Decline in Management Fees

According to data from industry expert Preqin, the average management fee for buyout funds that closed or were still raising capital as of June 2024 dropped to 1.74% of investors' committed capital, down from the previous low of 1.85% in 2023.² This marks the lowest level since records began in 2005.

• Mean Buyout Fund Management Fee: Decreased to 1.74% in 2024.

• Previous Low: 1.85% in 2023.

This downward trend in management fees reflects the increased bargaining power of investors, known as limited partners (LPs), who may be becoming more cautious and judicious about committing new capital in the current economic climate.

Factors Contributing to the Decline

Challenging Fundraising Environment

Over the past two years, private equity firms have struggled with exits, as traditional avenues like initial public offerings (IPOs) and corporate acquisitions have been limited by:¹

• Higher Interest Rates: Increased borrowing costs have made financing deals more expensive.

• Valuation Disputes: Disagreements over company valuations have hindered deal-making.

• Economic Uncertainty: Global economic challenges have reduced investor confidence.

As a result, firms have returned less capital to investors, leaving them with less liquidity to reinvest in new funds.¹

Greg Durst, Senior Managing Director at the Institutional Limited Partners Association, stated:

"Because of that pressure on fundraising, that's why [buyout managers] are going to make concessions on fees and terms. They're being very slow and judicious about how they're going to be making new commitments."¹

Fund Size and Competition

Another factor influencing lower fees is the growth in fund size and increased competition among fund managers:

• Larger Fund Managers: As fund sizes have increased over the past 20 years, some of the bigger managers, who receive a larger volume of fees, have chosen to cut their rates to attract more investors.¹

• Smaller Firms: Smaller managers are reducing their fees to remain competitive and appeal to investors who might otherwise focus on larger firms.²

A London lawyer advising mid-market private capital funds noted:

"Many investors have concentrated on relationships with the largest fund managers. This means that smaller managers at the lower end of the market are having to work harder."¹

Investor Negotiations and Fee Structures

Bigger limited partners (LPs) have more leeway to negotiate on fees:

• Volume Discounts: Larger firms managing multiple strategies (e.g., private credit and buyouts) offer fee breaks across all of them.

  • Example: Investing in one strategy might have a 2% management fee, but committing to three strategies could reduce the rate to 1.75%.²

• Negotiation Power: Large investors writing substantial checks (e.g., $25 million to $100 million) can secure lower fees.¹

Stability of Performance Fees

Despite the decline in management fees, performance fees (also known as carried interest) have remained relatively stable:

• Average Carried Interest: Hovered around 19.5% of fund profits over the last 20 years, after a minimum return threshold for investors is met.¹

This stability indicates that while fund managers are willing to reduce management fees to attract investors, they are less inclined to adjust the performance-based compensation that aligns their interests with those of the investors.

Contrasting Trends in Private Debt Funds

Preqin's data reveals that there has been no notable downward pressure on management fees for private debt funds:²

• Investor Interest: There has been an upsurge in investor interest in private debt investments.

• Fee Structures: Management and performance fees for private debt funds may be lower than for other private asset classes, depending on the risk and potential returns.

Implications for Investors

The decline in private equity management fees has several implications for investors:

Increased Bargaining Power

• Negotiation Leverage: Investors have more influence in fee negotiations, especially larger LPs who can commit substantial capital.

• Better Terms: The competitive fundraising environment allows investors to secure more favorable fee structures and investment terms.

Enhanced Returns Potential

• Lower Fees: Reduced management fees can lead to higher net returns for investors over the life of the fund.

• Cost Efficiency: Investors can allocate capital more efficiently, with a lower fee drag on their investments.

Due Diligence Importance

• Assessing Fund Managers: Investors need to carefully evaluate fund managers, especially smaller firms reducing fees to compete.

• Risk Considerations: Lower fees should not be the sole criterion; the quality of the investment strategy and the track record of the fund manager remain paramount.

Diversification Opportunities

• Access to Top Managers: Fee reductions may make it more feasible for investors to diversify their portfolios by investing with multiple fund managers.

• Exploring New Funds: Investors might consider smaller or emerging managers offering competitive fees and innovative strategies.

Conclusion

The decline in private equity management fees to their lowest levels since records began reflects the shifting dynamics in the industry. Fund managers are making concessions on fees and terms in response to a challenging fundraising environment and increased competition. For investors, this presents an opportunity to negotiate better terms and potentially enhance their net returns.

However, while management fees are decreasing, performance fees remain stable, indicating that fund managers are maintaining their incentive structures aligned with investment performance. Investors should continue to perform thorough due diligence, balancing the attractiveness of lower fees with the quality and reliability of fund managers.

As the private equity landscape evolves, both fund managers and investors will need to adapt to these changes, seeking mutually beneficial arrangements that support long-term investment objectives.

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_{1. Financial Times, Management fees on private equity buyout funds have fallen to their lowest levels since records began in 2005, 2024.}

_{2. Private Equity Wire, Tough fundraising environment sees PE management fees drop to record low, 2024.}

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