Lower Fee Private Equity Feeders Aim for Advisor Market
Alts platforms and private equity managers have been laying the groundwork for a wider slate of low-cost feeder fund vehicles for advisors, aiming to avoid the 100 basis point bite of the market’s priciest structures.
Feeder funds have become more common as private equity managers target the high-net-worth market and advisors seek to diversify client portfolios into alts, spreading from early usage primarily in the wirehouses and large private banks to a broader array today of product platforms, managers, and advisory firms. Feeders typically pass along the 2% management and 20% performance fees from the underlying private equity funds and then tack on administrative fees of up to 100 bps a year.
Cost is one of the impediments to greater high-net-worth client adoption of illiquid private equity funds, market watchers say, and that’s one reason many managers in the past year jumped aggressively into product development of non-listed registered alts funds for the advisor market. Some managers have cited a potential ceiling in sales of illiquid private equity funds to high-net-worth clients as motivation for their non-listed product efforts, and some of those new vehicles have come online with cheaper cost as a main feature.
But platforms developing low-fee feeders could determine whether the ceiling for illiquid funds may be higher than today’s market indicates. For now, most lower-cost options are available to independent registered investment advisors (RIAs) through platforms such as PPB Capital Partners and the iFunds arm of Mercury Capital Advisors.
Developing lower-fee models can be a smart play for alts managers in a market where many products carry high price tags, says Kimberly Flynn, managing director at XA Investments, which recently built a closed-end fund subadvised by Octagon Credit Investors.
“It makes sense that both hedge fund and private equity managers would try to find ways to reduce the cost to the end investor,” she says. “In alternatives, fees are not noise. You should really be thinking about the net-of-fees, net-of-expenses cost to clients.”
Net fees are especially important for advisors to outline for private equity vehicles that typically have a 10-year or longer life, and where a 100 bps feeder fee charged annually can add up to significant performance drag at the end of a fund’s life, Flynn says.
“Advisors need to account for the full impact of these fees,” she says. “They can radically change the investment proposition for an investor.”
That scenario played out in stark terms recently, says Brendan Lake, CEO at PPB, describing the reaction from a high-net-worth client of an RIA who was being pitched a new private equity fund by a manager that touted its prior fund as having 30% returns. The investor was surprised at the figure, given that he had been in that same prior fund through an account at one of the wirehouses, but had only earned 21% – a 900 bps difference that traced back to annual feeder fees charged over the life of the fund.
“That’s what has given us a reason to exist,” Lake says, citing interest from RIAs that want to deliver private equity to clients at the same cost that institutional investors pay or for as low a fee as possible, from the single digits to 25 bps.
PPB’s model entails a combination of automation, volume pricing discounts from managers, strategic partner relationships, and policies that avoid added costs to investors, such as not stockpiling client cash as much as 18 months in advance of expected capital calls, Lake says.
Mercury’s platform also offers lower-fee feeders to wealthier clients, with 57 bps options for clients with $1 million or more to invest, and no-fee options for investors that can meet the private equity manager’s stated minimum investment level, says Donal Mastrangelo, head of U.S. iFunds distribution. Mercury, which is a placement agent, only collects its sales fees directly from the manager and doesn’t participate in non-institutional share classes that try to pass on those charges, he adds.
Fees are “always front and center” for advisors on any strategy, but especially on alternatives, Mastrangelo says. “The second layer is how much of those fees are disclosed,” he says. “That becomes the enigma for advisors to solve for. Some firms are reticent, others are more transparent, but it can take a little bit of forensic accounting to understand what the total cost of ownership is over the life of the fund.”
But lower cost isn’t the only concern on advisor checklists. Access to well-regarded managers and top-performing funds is also a big priority, says George Lucaci, partner and senior advisor at Mercury. “There’s no doubt about it – that’s what the bigger producers want,” he says.
Access to top private equity brands drives investment decisions for many advisors in part because they associate those names with quality, Flynn says. That also means advisors are willing to have clients pay more for those funds, she says.
And it’s no accident that access to top brands often is reserved for advisors at the wirehouses or private banks – the firms where feeders typically carry the highest fees.
“The larger [advisory] firms follow the path of least resistance – investing their clients with the largest private equity sponsors in the world,” Mastrangelo says. “It’s like buying IBM.”
However, at least one mega-size private equity manager is exploring options with PPB to develop its own low-cost feeder structures, Lake says. “Some of these firms want a bigger piece of this market,” he adds.