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Limited partners limiting the general ones

May 11, 2010

It is Econ 101 that when a firm makes outsized profits, other firms will rush into the market to try to get a piece of the action.

For a while funds of all colors (VC, PE, hedge) were making (or claiming) outsized profits and more and more of them tried to get into the game. The result wasn’t necessarily a lowering of costs (at first), but it was arguably a lowering of quality.

Too much money in too many funds, some of whom with little or no real investment thesis, that were either just following the pack or trying to make money off of fees, management or otherwise (ie: “monitoring fees”)

Happily, those days seem to be behinds us, one of the benefits of a global economic meltdown. Undoubtedly, the days of outsized funds (and fees) will return but for the moment, with fund-raising becoming scarce, there has been a much needed cleansing of the fund market and some sanity returning to the fee structure of funds.

As highlighted:

In September the Institutional Limited Partners Association (ILPA), a network of institutional investors in private equity, issued a set of best practices that general partners should consider accepting if they want limited partners’ business. It calls for greater transparency, more favourable contractual terms and more generous profit-sharing. It is hardly “The Communist Manifesto”, but it has sent ripples through the industry.

This is good for the industry as it sets some reasonable standards that LPs can ask for and eliminates the “buyer beware” environment for fund investors.

True, this will be a bit of a crutch for LPs unable (for whatever reason) to negotiate for reasonable terms on their own. But in the investment business, the benefit of the doubt should go to the LP. It is up to GPs to justify their fees and terms, and if they stray from best practices, it is up to them to justify why.

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