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refurb

I'm not sure I understand the concern:

- company is bought in a LBO by a PE company

- PE company has onerous fees as a part of the buyout agree (which the target company agrees to)

- the victim are institutional investors who pay these high fees, but were willing partners to the LBO

I mean it sounds like one group of people from Wall Street trying to rip off another group from Wall Street.

Can't the institutional investors just pull their investment if they think it's a bad deal? Can't they read the fine print on the LBO deal?

Do we need to somehow protect institutional investors who manage tens of billions of dollars? Are they a victim that needs protection?

How is it all that different from a company owned by a majority shareholder who makes bad business deals? What do institutional investors do then? Presumably they use their voting power to stop it, or else just exit their position?

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You are absolutely right.

A few comments:

- The target company doesn't "agree" to the fees. The PE fund owns the target company outright, so they can manage it however they like. It would be like saying that when you cut the grass on your own lawn (even if you cut it in onerous ways, to stretch the metaphor), the lawn doesn't have to "agree" to be cut. Of course not. You own it, you can do with it as you please.

- You are correct that the victims were the institutional investors (LPs), because the extra fees reduced the profits in the fund (less money was distributed from the portfolio companies to the fund, which the LPs would get, because some of the money was paid in fees directly to the managing PE firm). I say "were" because LPs have absolutely become aware of this problem. This is old news. The article is from 2014. Today, all partnership agreements state that the fee charged to the portfolio companies enter into the fund's waterfall. Problem solved.

- "Do we need to somehow protect institutional investors who manage tens of billions of dollars? Are they a victim that needs protection?" This is a super important point, and something that is often overlooked in PE discussions. It's like all the hand-wringing about the "poor creditors" who lose out when PE deals go bad. Guess what, these "creditors" are investment banks, like Goldman Sachs. However you otherwise feel about GS, there is no reason to ever feel sorry for them.

> Can't the institutional investors just pull their investment if they think it's a bad deal? Can't they read the fine print on the LBO deal?

I can think of a few reasons why they don't.

They need 'uncorrelated returns' which PE provides, and it might be worth paying extra fees for this. That does not mean the fees are fair, it just means there is not enough competition. Also institutional investors might not perfectly rational and informed, as the article notes some of these fees are somewhat obscured and investors might be looking more at direct management fees. Relatedly, there is probably an asymmetry of skills and power, as institutional investors are second or third tier firms whereas PE firms are top tier. Finally, there is the usual agency problem, institutional investors are not sufficiently incentivised to reduce fees, because the fees are effectively paid by people who put the money in the funds, namely you and I, via pension funds or sovereign wealth funds.

> Do we need to somehow protect institutional investors who manage tens of billions of dollars? Are they a victim that needs protection?

We need to protect the people who ultimately put the money in the funds, not the chain of asset managers extracting their rents on top of it. Historically for PE these were high net worth individuals, so nobody cared, but nowadays they are California's teachers and Japanese pensioners.

> How is it all that different from a company owned by a majority shareholder who makes bad business deals? What do institutional investors do then? Presumably they use their voting power to stop it, or else just exit their position?

It is a similar agency problem I think. It's easier if you're investing directly in companies, because there are many companies competing with each other to attract institutional investors' money, so they care more about making investors happy.

The underlying question is why aren't PE firms competing with each other to provide lower management fees to attract more institutional money. This has happened in public market funds, with Vanguard for example providing very low fees. But for some reason it doesn't seem to happen in private markets. PE firms compete on where to put the money, trying to win deals against each other, but do not seem to compete that much on where they get the money. I don't know why. It could be that quantitative easing made money so abundant that they had more money than deals to spend it on, so there was no reason to compete.

Edit: to be fair this seems to be happening somewhat now [1]

[1] https://www.ft.com/content/05b0d935-678b-418c-8a86-b1a99bb04...

Thanks for the well thought out reply.

> They need 'uncorrelated returns' which PE provides, and it might be worth paying extra fees for this.

I get they need "uncorrelated investments" as a part of their portfolio management, but that's an institutional investor decision. If their clients demand it, then you make it clear "ok, but you need to realize the fees are ridiculous". Or make alternative investments. All of this is in the control of the institutional investor.

But clearly they can make an informed decision if those fees are reasonable? I would disagree a huge institutional investor has a asymmetry of skills and power - CALPERS has a huge team of financial experts with experience across the financial industry. They can hire in house lawyers to go through contracts to their hearts delight - and negotiate (if they can) different terms. And i would argue institutional investors are heavily incentivized to reduce fees because they directly impact the returns they can get, which is linked to compensation. These aren't mom-and-pop organizations buying penny stocks, they are some of the most sophisticated investors out there. They turn down investments all time because they don't make sense.

> We need to protect the people who ultimately put the money in the funds, not the chain of asset managers extracting their rents on top of it.

But that's the fiduciary duty of the institutional investors. If they can't do the required due diligence, they shouldn't be investing on behalf of the individuals they represent. And as mentioned above, their compensation is directly related to making good returns.

> The underlying question is why aren't PE firms competing with each other to provide lower management fees to attract more institutional money.

It's because they don't need to. It's a problem as old as the history of PE. The old 2 & 20 has been an issue for a long time. If you have a product with high demand and low supply, you can set the terms. It's a sellers market. There are plenty of other investment vehicles that have onerous fees and lack transparency. Presumably institutional investors decide whether those fees are worth it or not.

I have a hard time feeling sorry for highly sophisticated investors complaining about the terms of an investment they had complete free will over investing or not.

It's sounds more to me that institutional investors "want their cake and to eat it too". They want access to LBO PE investments, but want better terms that they can't actually get themselves.

> These aren't mom-and-pop organizations buying penny stocks, they are some of the most sophisticated investors out there

Agreed, but they're facing KKR and Apollo, who are even more sophisticated. PE is a small proportion of CALPERS portfolio. They can't be the top expert everywhere, and they can't be better at PE than PE firms.

> They turn down investments all time because they don't make sense.

But can they turn down a whole asset class?

> If you have a product with high demand and low supply, you can set the terms. It's a sellers market

Maybe we can agree that PE firms are not competing enough on the liabilities side, which makes it difficult for institutional investors to negotiate fees down?

> I have a hard time feeling sorry for highly sophisticated investors complaining about the terms of an investment they had complete free will over investing or not.

To me that sounds like the typical free market fallacy, "no reason to complain or ask for regulation because you can just buy the product elsewhere if you're unhappy". Sure, that works fine when there's enough competition, but I'm not convinced it's the case in PE.

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