Stock Market Soars, but Private Equity Fund Managers Retreat

There is an analysis that as overseas private equity fund (PEF) managers are failing to achieve previous levels of investment exits, the influence and pressure from fund limited partners (LPs) are intensifying. Increasingly, general partners (GPs) are being asked to contribute more of their own capital and participate in co-investments where it is difficult for them to receive management fees.

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According to Bloomberg on the 28th (local time), Japanese comprehensive financial group ORIX recently stated in a published report that this "shift in power" is leading GPs to reluctantly lower management fees to retain LPs. The report explained that this is due to the historically slow pace at which capital is being returned to LPs as investment proceeds.

The report shows that last year, the capital distribution ratio relative to total assets under management (AUM) for the entire industry fell to 6%. This is less than half of the 10-year average of 14%. The report pointed out, "From the LPs' perspective, as the years go by without large-scale exits, the gap between expectation and reality is widening." ORIX not only manages its own private equity funds, but also provides acquisition financing such as leveraged buyouts (LBOs) that private equity funds use. As a result, it has been able to analyze in detail the trend of buyout funds holding investment assets for longer periods.

While LPs have their funds tied up waiting for exits, GPs are now putting a larger share of their own money into new funds. According to ORIX's analysis, whereas GP commitments used to account for around 1-2% of the total fund, the average is now almost double that percentage.

Fund managers are also having no choice but to accept lower fees. According to the report, the average management fee for buyout funds dropped to 1.6% in the middle of last year. This is not only lower than the traditional 2% level but also the lowest figure ORIX has recorded to date. Moreover, LPs are now demanding co-investments in which GPs cannot receive management fees. Co-investment refers to the LP adding additional capital to a portfolio invested in by an existing GP selected by the LP. Since there are no deal sourcing or management costs, management fees are much lower or sometimes nonexistent compared to typical alternative investments. ORIX explained that such demands have now become the "basic expectation for attracting institutional capital."

The background for GPs' inability to swiftly exit investments has been analyzed as the increased difficulty of raising the value of portfolio companies. According to the ORIX report, GPs that acquire companies need to achieve EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) growth of 10-12% over five years. This is in stark contrast to the past 10 years, when 5% growth was considered sufficient in the industry.

In South Korea as well, some LPs are already increasing co-investments and intensifying pressure for capital returns. The Military Mutual Aid Association is a representative example. Recently, it announced a 200 billion won commitment to a single fund manager, but only three companies applied. This was because, as a co-investment fund-of-funds, there were restrictions on management strategy and the fee rate was low. The purpose is to maximize investment effectiveness by reducing management fees, since the fund invests directly into the portfolios of GPs invested in last year.

Other LPs, including pension funds and mutual aid associations, are also delaying or readjusting investment plans as funds have been moving into the stock market in the first half of the year. Due to the sharp rise in the stock market, cases are increasing where funds that remained in mutual aid products are not being renewed or are canceled before maturity. An investment banking industry source explained, "In the PE industry, they are facing the double challenge of reduced commitments and a lack of obvious investment destinations that can easily increase company value."

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