| > Can't the institutional investors just pull their investment if they think it's a bad deal? Can't they read the fine print on the LBO deal? I can think of a few reasons why they don't. They need 'uncorrelated returns' which PE provides, and it might be worth paying extra fees for this. That does not mean the fees are fair, it just means there is not enough competition. Also institutional investors might not perfectly rational and informed, as the article notes some of these fees are somewhat obscured and investors might be looking more at direct management fees. Relatedly, there is probably an asymmetry of skills and power, as institutional investors are second or third tier firms whereas PE firms are top tier. Finally, there is the usual agency problem, institutional investors are not sufficiently incentivised to reduce fees, because the fees are effectively paid by people who put the money in the funds, namely you and I, via pension funds or sovereign wealth funds. > Do we need to somehow protect institutional investors who manage tens of billions of dollars? Are they a victim that needs protection? We need to protect the people who ultimately put the money in the funds, not the chain of asset managers extracting their rents on top of it. Historically for PE these were high net worth individuals, so nobody cared, but nowadays they are California's teachers and Japanese pensioners. > How is it all that different from a company owned by a majority shareholder who makes bad business deals? What do institutional investors do then? Presumably they use their voting power to stop it, or else just exit their position? It is a similar agency problem I think. It's easier if you're investing directly in companies, because there are many companies competing with each other to attract institutional investors' money, so they care more about making investors happy. The underlying question is why aren't PE firms competing with each other to provide lower management fees to attract more institutional money. This has happened in public market funds, with Vanguard for example providing very low fees. But for some reason it doesn't seem to happen in private markets. PE firms compete on where to put the money, trying to win deals against each other, but do not seem to compete that much on where they get the money. I don't know why. It could be that quantitative easing made money so abundant that they had more money than deals to spend it on, so there was no reason to compete. Edit: to be fair this seems to be happening somewhat now [1] [1] https://www.ft.com/content/05b0d935-678b-418c-8a86-b1a99bb04... |
> They need 'uncorrelated returns' which PE provides, and it might be worth paying extra fees for this.
I get they need "uncorrelated investments" as a part of their portfolio management, but that's an institutional investor decision. If their clients demand it, then you make it clear "ok, but you need to realize the fees are ridiculous". Or make alternative investments. All of this is in the control of the institutional investor.
But clearly they can make an informed decision if those fees are reasonable? I would disagree a huge institutional investor has a asymmetry of skills and power - CALPERS has a huge team of financial experts with experience across the financial industry. They can hire in house lawyers to go through contracts to their hearts delight - and negotiate (if they can) different terms. And i would argue institutional investors are heavily incentivized to reduce fees because they directly impact the returns they can get, which is linked to compensation. These aren't mom-and-pop organizations buying penny stocks, they are some of the most sophisticated investors out there. They turn down investments all time because they don't make sense.
> We need to protect the people who ultimately put the money in the funds, not the chain of asset managers extracting their rents on top of it.
But that's the fiduciary duty of the institutional investors. If they can't do the required due diligence, they shouldn't be investing on behalf of the individuals they represent. And as mentioned above, their compensation is directly related to making good returns.
> The underlying question is why aren't PE firms competing with each other to provide lower management fees to attract more institutional money.
It's because they don't need to. It's a problem as old as the history of PE. The old 2 & 20 has been an issue for a long time. If you have a product with high demand and low supply, you can set the terms. It's a sellers market. There are plenty of other investment vehicles that have onerous fees and lack transparency. Presumably institutional investors decide whether those fees are worth it or not.
I have a hard time feeling sorry for highly sophisticated investors complaining about the terms of an investment they had complete free will over investing or not.
It's sounds more to me that institutional investors "want their cake and to eat it too". They want access to LBO PE investments, but want better terms that they can't actually get themselves.