If You Pay More, Do You Actually Get More?

The typical private fund is organized as a limited partnership or limited liability company that is managed by a general partner or manager.  The fund manager is usually compensated in three ways – an annual management fee (often 2%), a carried interest (often 20%), and an investment in the fund (often 1%).  In a recently presented paper, Professors David T. Robinson and Berk A. Sensoy tackled the question of whether private fund managers actually earn their keep.

Given the limited rights of limited partners and members and asymmetrical access to information, one might expect that these professors would conclude that fund managers who charge more, actually under perform.  Based on an analysis of 837 buyout and venture capital private equity funds from 1984-2010 to, the two scholars reach the opposite conclusion:

We find no evidence that high-fee funds underperform an on a net-of-fee basis [sic].  Management fees and carried interest are generally unrelated to net-of-fee cash flow performance.  This suggests that private equity GPs that receive higher compensation earn it in the form of higher gross returns.  When we examine the relation between GP ownership and performance, our evidence flatly contradicts the argument that GPs with low skin in the game demonstrate poor performance.

You can read the entire paper here.  Unfortunately, the authors don’t reveal the source of their data, but rather mysteriously describe it as having been “obtained from a large, institutional limited partner with extensive investments in private equity”.  The paper was presented at the inaugural Sustainability and Finance Symposium held last week which was hosted by the California Public Employees Retirement System and the UC Davis Graduate School of Management.


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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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