Private equity firms, which are facing tough times raising funds due to the economic slowdown, have started reducing management fees and carry charges for successful closures of their respective funds.
The investment firms, or General Partners (GPs) as they are known, apply 2/20 rule with their investors, or limited partners (LPs), from whom they raise the corpus.
Under 2/20, investors typically pay 2% of the committed capital to the management company to manage the fund and 20% of the returned funds above the initial capital as an incentive.
Recently, Elara Capital which raised a fund for Network18’s film production venture from the overseas market had to tweak its fee structure for the exercise.
“We have changed our ratio and are now charging just 1.5% in terms of management and the carry has declined from the earlier 20% level,” said Raj Bhatt, chairman and chief executive officer of the UK-headquartered Elara Capital.
Industry experts said the 2/20 rule is very much under pressure and companies in the fundraising business are reworking their approach by cutting back on the fees being charged.
“The 2/20 ratio itself is being questioned and limited partners don’t think that the fund managers can justify those kind of fees for their services,” said Bijal Doshi, executive director, Euromax Capital.
The general consensus seems to be that anything between 1-1.5% management fees is the standard norm keeping the changing market scenario. As for the 20% carry charge, it is down to 10-15% bracket depending on the GP’s performance records.
Avinash D Persaud, non-executive director, Elara Capital said the private equity investment business is entering a period of lower return expectations and that makes it very hard to justify the 2/20 rule. “In the long run, equity markets yield 7.5% globally so if you are taking 2% of that then you are getting something not very far from the money market rate. So it’s hard to justify that ratio. There was a time when long-term yields were over 10% in which case taking a couple of percents of that was easier. Of course, in the emerging markets we have had growth rates much beyond the 10% number,” Persaud said.
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