Private equity and venture capital firms have been raking in the cash from return-hungry investors in 2019, but even the most popular firms winning mandates are waiting for the other shoe to drop as some investors are paying closer attention to fees, according to a recent industry surveys.
According to a new report from BDO, more than half of fund managers (50% of private equity respondents and 54% of venture capital respondents) said they are now being more selective when evaluating highly valued deals.
Some may cite WeWork’s failed IPO earlier this year, but either way many believe that a bear market in equities is right around the corner.
The majority (72%) of private equity funds interviewed by BDO expect an economic downturn within two years, while venture capital managers are slightly more optimistic with only 56% expecting market dip within the next two years.
Across a four-year timeframe, nearly all respondents expect a bear market. BDO officials stressed that time period is less than the length of most investment holding periods.
In preparation, fund managers are shifting their capital allocation strategies toward funding portfolio working capital needs over the next year. Roughly 28% of private equity managers are doing this and this is a slight increase from when BDO did the survey last year. Officials found that a greater number or 41% of venture capital managers are freeing up working capital in preparation for a downturn.
Both types of private market investors are on the hunt for secular trends in which to invest. Most of the deal activity remains in technology, with interest in 5G, artificial intelligence and the Internet of Things. There is also anticipation for deal activity within financial services and natural resources industries.
Competition for that deal flow is coming from other strategic buyers, hedge funds, mutual funds as well as competing firms, according to BDO.
The backdrop to the competition for deal flow is the carving out of niches within institutional investor portfolios. Much like hedge funds in recent years, private equity and venture capital firms have turned to co-investments and direct investments to increase their private market exposure and in the process reduce or eliminate management fees.
In BDO’s survey, 43% of private equity funds report offering co-investments to LPs this year in a response to growing demand for it.
Callan in its recent investor fee survey found that pricing remained strong generally across alternatives, such as private real estate and funds of hedge funds. The least expensive option remains liquid multi-asset class products.
The consulting firm, however, didn’t disclose average fees for private equity or venture capital funds.
Private real estate within open-end funds and separate accounts has only come down marginally with a hefty premium over public market asset class pricing. The average fee is 85 basis points and $1.2 million per mandate on an average mandate size of $195 million. Downward pressure on fees only appears in mandates above $500 million with only a handful of firms remaining active in the core open-end fund space, according to Callan.
The data was gathered from the consulting firm’s fee database of over 350 investment firms and 165 institutional investors.
When it comes to liquid multi-asset class products the pricing has come down over the last five years, officials said, even as the average mandate sizes have mushroomed. The firm’s sample size was small with an average mandate size of $127 million with average fees of 54 basis points and $517,000 per mandate.
Meanwhile, the most expensive alternatives proposition remains funds of hedge funds, according to Callan, which found that many businesses in the space have not survived given the pressure on fees and capital inflows. The average fee is a steep 112 basis points or $778,000 per mandate.