Private equity managers have extracted at least $20bn in hidden fees from clients over the past two decades, boosting their own profits at the expense of end investors, according to a new study.
The research by Ludovic Phalippou, a finance professor at the University of Oxford’s Saïd Business School, is likely to fuel the debate over private equity fees, which are already under examination by US regulators.
The Securities and Exchange Commission issued a warning in 2014 to the $3.5tn private equity industry to expect increased scrutiny after finding numerous examples of fees and expenses being charged inappropriately to investors.
Mr Phalippou and two co-authors examined the accounts of 592 companies that were bought by private equity managers between 1981 and 2013. They found that $20bn was paid to private equity managers by the companies, reducing their value when these businesses were sold or listed on the stock exchange.
“Investors do not negotiate on the hidden fees charged to companies owned by private equity managers. They can negotiate a discount on the management fee but they do not negotiate on the content of the contracts [known as master services agreements] they agree with private equity managers,” said Mr Phalippou.
He added that the study was not able to capture all the different types of hidden fees and expenses, such as private equity managers’ use of private jets.
Private equity managers often pay some of these hidden fees back to investors via reductions in annual management fees, but Mr Phalippou believes the reductions could go further. “The official expense ratio reported by investors can be significantly understated,” he said.
Calpers, the largest US public pension fund, last month disclosed for the first time details of the performance fees, known as carried interest, that were paid to private equity managers over the past 25 years.
Mr Phalippou’s analysis indicated that Calpers paid around $2.6bn in hidden fees on private equity investments made between 1991 and 2014 on top of its $3.4bn bill for carried interest. Around $1.3bn was repaid to Calpers as rebates against annual management fees.
Calpers said it has been “rewarded appropriately” for the risks taken with its private equity investments. The scheme will this week discuss proposals to drop the benchmark employed to measure the performance of its private equity investments.
Eileen Appelbaum, senior economist at the Center for Economic and Policy Research, the Washington think-tank, said: “If the benchmark is eliminated, private equity managers will be able to continue to collect outrageously high fees from the retirement savings of public workers without being judged on whether their performance warrants these bonuses. Taxpayers and workers will be the losers.”
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