Follow the data and defend the charge cap – Clacher and Keating

Today’s blog is the continuation of yesterday’s introduction to problems with the proposed exemption of the charge cap. Your authors are Con Keating and Iain Clacher.

We responded to the earlier consultation on illiquid private ‘market’ investments and performance fees. Our response was negative, and this has not changed, even though we have seen the publication since of two ‘official’ reports which promote this form of investment. In addition to the Road Map’s “Case for” narrative, we will comment on these publications in the course of our responses to the questions posed here.

Before moving to consideration of the questions posed and responses to them, it is appropriate to recognise how questionable manager evaluations of performance have been in the past. It happens that this issue was raised in the context of two recent valuations by Pitchbook. See Figure 6 below.

The commentary offered by Pitchbook concerns the two most recent valuations contained in the yellow box. “The distribution rate has explained nearly 60% of the variation in one-year returns. However, this relationship broke down during the past two quarters. For example, based on the distribution rate of 28.8% in Q1 2021, the expected one-year return is 20.9% versus the reported return of 51.3%. The discrepancy between these two numbers comes from significant markups to net asset value (NAV), which represent unrealized returns. If these high valuations are not realized, it could represent a significant drag on future returns.”

It is also noticeable that there are many earlier reported positive returns which the relation with distributions suggests really should be negative – the eight returns contained within the green box. Perhaps most telling is that there are no negative reported returns which the relationship would suggest should be positive.

Figure 6: Distributions and Returns

As the returns achieved must all ultimately be rooted in distributions made[1], we should expect the regression line shown to be steeper, with a slope approaching unity, and with the R2 statistic also approaching unity.

The Pitchbook commentary continues with: “The only period with a similar dynamic occurred immediately post-GFC. However, during this period, performance was recovering from a sharp markdown to average levels.”

As a key ingredient of any value for money formulation, it is worth understanding the reported net returns achieved and the total fees deducted for investments by UK pension funds in private equity over the period 2018 – 2020. The sample sizes are also shown. It contains funds of all vintages owned by these funds. It does not have any adjustment for undrawn commitments.

The high levels of fees relative to those applicable to listed equivalent funds is obvious. It is perhaps surprising that infrastructure should have significant large loss experience which reduces the mean return to less that the median.

Table 3:  Annual Net Returns and Fees UK DB Pension Funds 2018-2020

Net Returns Fees
No. of Portfolios Mean Median Mean Median
Infrastructure 651 6.7 7.8 1.12 1.19
Private Equity 1773 12.66 11.96 4.42 1.35
Private Debt 773 5.39 5.63 2.09 1.18

Source: ClearGlass

The distribution of fees is also informative. Figure 7 shows this for the ClearGlass dataset:

Figure 7: Distribution of Fees 2018-2020

The remarkable thing here is just how skewed the performance fees are – the mean return occurring around the 80th percentile. In addition, there are around 4% of results which are clearly corrections in excess of the ad valorem fees.

The distribution of performance fees is shown as Figure 8 from the ClearGlass dataset.

Figure 8: Performance fee distribution 2018 – 2020.

In this period, 9 percent of funds found it necessary to rebate some part of previously accrued fees (“clawback”) and 44% were unable to claim any performance fee.

The most contentious area of private market investment is of course the returns achieved by investors. The British Private Equity and Venture Capital Association (BVCA) report for realised returns: “Across the industry as a whole since 1991, investors have received 1.43 times their original capital invested.” This is in fact a very poor return for an investment of the ten-year term that is meant to be the typical private equity commitments, just 3.6%. Even if we consider  the BVCA’s total returns figure of 1.80 times the original investment, the return is just 6.0% over ten years and that figure is inflated by any performance fees deductible on the unrealised portion. These figures really do not reconcile with the BVCA’s statement: “Industry return since 1991, 15.1%. Overall industry since inception internal rate of return since 1991.” In order to reconcile those two sets of figures, it would be necessary for the experienced term of investment to have been just 2.55 years for the 1.43 realised return, or 4.2 years for the 1.80 unrealised return.

Given these confusions, and difficulties establishing relevant benchmarks, it is perhaps worth considering the reported experience of a group which has been a major investor in private equity funds, US State Pension Plans. Over the past ten years this shows private equity failing on average to outperform US equity.

Table 4: Ten Year returns US State Pension Schemes

US Stocks Private Equity
Highest return 15.02 16.91
Median 13.17 12.65
Mean 12.9 12.75

Source: Clearwater

This ends our commentary, leaving only the five multi-part questions posed in the consultation document and our answers to those, which will be published on Monday.




[1] Distributions are simply the sum of returns of capital and returns on that capital.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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1 Response to Follow the data and defend the charge cap – Clacher and Keating

  1. Pingback: Keating and Clacher on excluding performance fees from the charge cap. | AgeWage: Making your money work as hard as you do

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