Delano reported in a that Norges Bank Investment Management found that leveraged buyout funds “outperformed public equities, on average, by 3% to 4%, annually,” whereas venture capital and growth equity funds “have underperformed by 1% to 2%,” on average. The study covered private asset funds with vintage years that started in 1985 to 2016 with performance data up to 2Q23.

Value creation through better operations

René Paulussen, alternatives leader at PWC in Luxembourg, noted that returns on private equity have been under pressure on the back of “inflation and high interest climate, which have been key drivers.” To generate return in the current environment, either the valuation of your target at the entry point goes down or the income increases. Indeed, the higher financing cost make the previous economics based on leverage not work anymore, he said in an interview.

Paulussen thinks that digitalisation and GenAI “create operational efficiencies through cost reductions.” He also suggested that focussing on niche markets instead of the general real estate market, for instance, enables astute investors to do well in sub-sectors such as in “student and senior housing, data centres and the whole infrastructure world including energy transition.”

“Large private equity [houses], the historical ones, said last year that we are going back to [managing] businesses,” stated Brieuc Malherbe, venture capital/capital market leader at PWC. He thinks that it means that you need to perform deeper due diligence and restructure the companies to ensure a growing and sustainable business.

Is the 2 and 20 fee structure under pressure?

The 2 and 20 structure refers to the standard management fee of 2% of assets annually, while 20 refers to an incentive fee of 20% of profits above a certain threshold. This “carried interest” is generally paid if the fund achieves that minimum return.

“With returns lower, costs are under pressure, so fees as well,” stated Paulussen. Given the challenging fundraising efforts, he noted that many GPs would like to lock in large pension funds as anchor investors and are therefore ready to offer them preferred rates.

Everything can be negotiated. Malherbe observed some newcomers in the industry or GPs that experienced poor performance on prior vintages may go as far as to give up a large part of the management fees (going down to levels as low as 0.25% to 0.50%) to tease anchor investors. Confident about the performance of their fund, GPs concentrate instead on the carried interest, which is gained at the end of a fund life. A long wait for the GP to cover expenses.

Independently, 20% of carried interest is generally retained by the GP once its fund achieves a minimum threshold, say 12%. Malherbe also observed that that some GPs may offer escalating carried interest. Indeed, the carried interest may reach a level of 40% or even higher once achieving a performance of 18%, for instance.

When they prove themselves, they can more easily return to a standard remuneration. On the other hand, Malherbe doubted that a player like Blackstone makes many concessions given its ease in raising funds.

“It’s really the big players who still manage to get the [cash] from the investors, but everyone else around is struggling,” said Paulussen. He reported that a research piece published by PWC Luxembourg concluded that around 50% of the AuM in mutual funds will be managed by the top 10 in the world by 2027-28. An ever greater concentration in alternative funds is also observed. A frightening thought given the power assigned to the happy few in control of those asset managers. 

Who cares about benchmarks

Malherbe thinks that the investors do not look at benchmarks, but rather crudely at the internal rate of return, or IRR. The discussion is less philosophical than your correspondent would have thought: “if we want to have 12% IRR for investors, obviously we need to get 16%, otherwise we don’t get money,” said Malherbe when referring to GPs’ way of thinking. Paulussen thinks that investors focus on the IRR target written in the prospectus. “That is their benchmark.”

Increasing liquidity has a cost

Paulussen commented that large asset managers such as KKR have their sights on assets belonging to retail investors. He estimated that less than 10% of retail investors own private assets whereas some players, such as Blackstone, expect that amount to climb to 50% (he did not provide a timeline).

As PE investments are currently the reserve of wealthy investors, Paulussen thinks that Eltif 2.0 bears the promise to open the access for retail investors to the asset class. Whether it is PE, real estate or infrastructure, he acknowledged that liquidity management is crucial. He sees positively some enhancement such as “working with credit lines, how you can keep some blue-chip investments” to facilitate access to cash. However, Malherbe stressed that maintaining a liquidity bucket eats into the IRR and therefore reduces the total return.

What about investing in listed GPs or in listed investment firms?

Private asset investments may be attractive for some investors, but many are reluctant to jump on the bandwagon given the limited liquidity of private funds.

Paulussen explained that investing into Blackstone shares gives you only some of the private investment exposure in the real estate, PE and VC. “If [the assets] are doing well, then [Blackstone] will get its management fees, the carried [interest] and the shares will go up… but you’re not exposed to the real game [in town] when this building is going up in value.” He claimed that as a Blackstone shareholder, you will get only part of the gains from the carried interest as explained in the fee section above. Yet Delano noted that the shares of Blackstone are quite liquid and its exposure is highly diversified. It is a give-and-take decision by the investors. 

Malherbe could think of only one listed private equity asset manager in Europe, Partners Group in Switzerland. However, he thinks that several European private equity managers, owned by their original founder or family, may be IPOed or put on the block to be acquired by large firms in the coming future.

Malherbe and Paulussen noted that there are few listed investment companies, such as Luxempart, with exposure to private assets and/or public assets in every country in Europe. Without commenting on the appropriateness of investing in those companies instead of private asset funds, they mentioned Eurazeo, a specialised asset manager based in France, and Groupe Bruxelles Lambert, a listed holding In Belgium.

This article was published for the Delano Finance newsletter, the weekly source for financial news in Luxembourg. .