Blackstone Group LP, the largest private-equity firm, may have to sacrifice some fee revenue to win a pledge from the California Public Employees’ Retirement System, the largest U.S. pension.
Blackstone and Calpers, which has committed more than $2 billion to the New York-based firm since 1994, may agree on a separate account with lower fees and more control over deals than traditional funds, a person briefed on the matter said last week. Calpers may allocate $500 million, according to a document on the pension’s website.
The discussions highlight how the biggest investors in private equity are winning concessions from the largest firms. While most fees at private-equity funds have barely budged over the years, New York-based Blackstone, KKR & Co. and Apollo Global Management LLC are leading firms willing to cut custom deals for their top clients as they seek to replace the mega funds raised before the financial crisis.
“There has been a noticeable change over the past 18 months with a lot going on below the surface, with side letters being written by investors cutting special deals,” Josh Lerner, a professor at Harvard Business School in Boston, said in an interview. “The bulk of the discounts are going to the large investors.”
Peter Rose, a spokesman for Blackstone, declined to comment.
Separately managed accounts are distinct from ordinary private-equity funds, in which commitments from numerous investors are pooled and the manager has discretion over how the money is spent. The accounts are limited to a single investor, usually command lower management fees and give clients the chance to choose which deals they invest in.
New Jersey’s pension system agreed in December to commit as much as $1.5 billion to Blackstone funds through an arrangement that will save the state more than $120 million in fees. KKR and Apollo both won $3 billion assignments in November from the Teacher Retirement System of Texas after offering discounts, the details of which haven’t been disclosed.
Apollo, based in New York, is investing a $600 million separate account for New York City’s public pensions. The account will be put to work over 12 to 18 months and focus on fixed income, Matthew Sweeney, a spokesman for the New York City Comptroller’s Office, said in an interview.
‘2 and 20’
The industry’s traditional structure of 2 percent management fees and 20 percent of profits for the private-equity firms, known as “2 and 20,” is still the norm, even as some of the largest funds are charging lower fees of about 1.5 percent, based on current marketing documents.
For the bigger buyout funds, those in excess of $1 billion, the average management fee has fallen 10 percent since 2008, according to data compiled by researcher Preqin Ltd. The downward trend may be steeper for managed accounts, Harvard’s Lerner said.
Blackstone, Apollo and KKR are seizing on their size advantage over rivals and their businesses beyond traditional corporate buyouts to entice pensions, endowments and sovereign-wealth funds to invest larger sums. Blackstone oversees $190 billion in assets.
Pensions and universities in the U.S. are working to put money to work as they grapple with funding gaps. Their bargaining power is constrained by the need for investment returns to fund their commitments to pensioners and university operations, said Oliver Gottschalg, a professor at French business school HEC Paris and author of several studies on private equity.
Some agreements, such as the Texas Teachers arrangements, have provisions that allow the private-equity firm to “recycle” profits into new deals, saving the time and resources devoted to raising funds.
U.S. public pensions nationwide had a median of about 75 percent of the funds needed to cover obligations in 2010, according to data compiled by Bloomberg. The California State Teachers Retirement System, the second-biggest U.S. public pension, said last month that the gap between its assets and projected obligations rose 13 percent to $64.5 billion in the latest fiscal year.
Big clients are applying fee pressure, Blackstone Chief Executive Officer Stephen A. Schwarzman said on an April 19 conference call with investors.
“Sometimes the largest investors in the world want a special discount for size and management fee breaks,” he said. “That’s something that has occurred in private equity for at least the last 10 years to 15 years, but those breaks are a little more accentuated. I would also say the dollars involved are larger than they were.”
Sovereign-wealth funds, which typically commit large pools of money at once, turned to the biggest buyout-fund managers when they started investing in the asset class, according to Jeremie Le Febvre, founder of Singapore-based TBG Capital Advisors, who advises firms on marketing their funds. The 2008 financial crisis boosted their bargaining power, he said.
“The smaller firms, most of whom structurally can’t offer similar discounts, will suffer,” Le Febvre said.
Pairings such as the pending Blackstone-Calpers tie-up underscore a deepening bifurcation in private equity. The largest firms are defining themselves as broader asset managers for whom private-equity funds are part of a slate of products. That range of investments, often including real estate, hedge funds and debt vehicles, appeals to big pensions desperate to plug funding gaps with returns exceeding public indexes.
The commitments come with strings, as well as wariness after a decade of market turmoil. Many of the industry’s biggest investors lined up behind the Institutional Limited Partners Association, or ILPA, in 2009 to recommend guidelines for how private-equity managers should behave. The principles include providing a better understanding of fees and striving to make rich profits only after delivering gains to clients.
Efforts such as ILPA’s have helped improve less-visible terms such as transaction and monitoring fees charged to portfolio companies by giving limited partners a larger share, Le Febvre said.
Discounts for large or early-bird investors have become part of the fundraising package even without separate accounts. Carlyle Group LP, the world’s second-largest private-equity company, will charge a 1.1 percent management fee for backers who commit $500 million or more to its latest flagship buyout fund, people familiar with the matter said in February. Smaller investors will pay as much as 1.5 percent.
“Fee structures are becoming more and more complex, a bit like the hotel or the airline industries,” Lerner said.
BC Partners Ltd., the London-based owner of Swedish cable company Com Hem, offered to cut management fees by 5 percent for those committing during its latest fund’s first stage of capital raising.
Permira Advisers LLC, a London-based firm seeking 6.5 billion euros ($8.5 billion), is offering a 5 percent reduction in management fees for the portion of any pledge exceeding 200 million euros, according to a marketing document obtained by Bloomberg News. The median individual commitment in buyout funds exceeding $4.5 billion is $40 million, Preqin’s data show.
KKR and Menlo Park, California-based Silver Lake Management LLC are among those offering similar deals.
“There has been some creativity among first-time funds and second-quartile funds on fee breaks,” said David Fann, chief executive officer of TorreyCove Capital Partners LLC, a La Jolla, California-based firm that advises the Oregon and Illinois pension plans on investments. “It is a marketing gimmick that seems to be effective with fee-conscious investors, for those who know they will re-up with the next fund. The war is still being fought on the management fees.”