Are private markets fees too high?

Written by Mark Machin | November 5, 2021

With fees on fund management and performance, do private market fund investments actually make sense?

Key Takeaways

For many new to the private markets space, fees often cause some pause. Fund fees are structured differently than in private markets, with a 1-2% management fee and a performance/incentive fee (in the neighborhood of 20%) above a target return.
While these fees may sound high, net of fees private funds (particularly top quartile ones) still outperform public markets - which is why almost all institutional investors hold positions in them.
Incentive fees can be beneficial in that they incentivize managers to actually make your money work - they're rewarded alongside you.
Often, fees are also not charged until hurdles are met - which for many asset classes don't kick in until above expected returns for public asset classes.

Transcript

I'm Mark Machin. I was formerly the president and CEO of the Canada Pension Plan Investment Board, or CPP Investments.

I think the biggest misconception or misunderstanding about private markets is fees. The headline fees look certainly look high relative to where a really low-cost public market investing has gone. Now, we're paying management fees, and you're paying carry. It can be quite tough, you know, particularly if you're running a pension fund or an endowment when the public looks at how many millions, hundreds of millions dollars, in my case, billions of dollars, we're spending in fees and carry for the very large private equity and private asset investing portfolio that we had. If you are in those top funds, in the top quartile funds, net of all those fees and expenses, you are going to significantly outperform what we could possibly have achieved in public markets and certainly in passive investing in public markets.

Carry is probably the biggest component of fees or expenses on a lot of these funds. But if you think about carry, number one, you only pay carry if the returns are of a certain hurdle, in most cases, the hurdle on the fund, you're only paying to carry over that. And secondly, it's really a share in success. So you're only paying it if the fund's been successful. Sure. Your carry might be very high if the fund's done incredibly well, but you're paying a share of success. When we looked at the amount of carry that we paid, we were happy with it because the returns had been, you know, above what we had required from a hurdle rate. Hurdle rates of six to 8% would be, you know, typical hurdle rates in private equity. And so you were only paying carry only kicks in above that type of return. Fund managers have to sweat a lot to get to the carry that you're then paying when you look at forward expected returns in public markets today; you would have to be very lucky in public markets to beat those returns.

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