by Val Cipriani, Investors Chronicle, June 18, 2024:
Private equity trusts often have poorly structured performance fees, which can make them ineffective and unfair to shareholders, according to Quilter Cheviot.
The wealth manager criticised how private equity investment trusts set performance fees in a report on governance at alternative investment trusts. It listed a series of principles that fee structures should follow to strike a balance between incentivising the manager and setting a “reasonable” fee for shareholders.
It added that it “is not the norm” that private equity performance fees are structured according to these virtuous principles. “Private equity firms may be unwilling to put different structures in place,” the report added.
These principles include not calculating performance fees just based on a trust’s net asset value (NAV). “This can lead to short-term outcomes and not match the experience of the shareholders,” the report said.
The performance period should also be three to five years, and managers should not be rewarded for unrealised gains. Additional factors at play are the fee’s cap, high watermark (a demarcation point that guarantees that investors do not pay performance fees twice for the same performance) and hurdle rate (which sets the minimum level of performance managers need to achieve to earn the fee).
Because of all these factors, performance fees can be hard to compare for investors and it isn’t easy to get the details on whether trusts adhere to these principles. A common arrangement in private equity is a 20 per cent performance fee on realised gains (‘carried interest’), but there are a number of variations.
For example, Pantheon International (PIN) has a 5 per cent performance fee, which applies when the NAV returns 10 per cent over the high watermark for the year. Seraphim Space (SSIT), a growth capital trust that has recently performed exceptionally well, has a performance fee of 15 per cent over an 8 per cent hurdle, also calculated on the NAV annually. Chrysalis (CHRY) was the most blatant case of a performance fee gone wrong when it paid out £112mn in performance fees to the investment manager based on a surge in valuation between April 2020 and August 2021, just to see its performance plummet soon after.
James Carthew, head of investment companies at QuotedData, said he is in favour of performance fees if they are well-designed, and agreed with some of the principles set out by Quilter Cheviot.
Read more here