one single solution jibe with your experiences as an
Hason: Absolutely. The fee structure may affect the strategy,
but really the strategy should weigh harder on determining the fee structure. Investors should always make sure
they have a very good understanding of the risk associated
with the strategy as to what they are investing in, as well as
expectations as to what the projected returns are, and then
set an appropriate fee structure. That should incentivize
all parties to maximize returns to investors and create a
fair compensation structure for the manager as well.
It is important to create the right alignments and incentives to compensate partners based on the returns they
generate consistent with the risk of what the strategy and
the mandate was originally created for. Investors don’t
mind when managers generate the returns necessary for
them to share disproportionately, but they should only be
earning their maximum payouts based on investors’ receiving their target returns, not in spite of it.
With regard to fees, there is no one-stop shopping solution. Let’s say an investor looks at opportunistic strategies in
debt versus equity; although the returns may wind up being the same, there may be different types of fee structures
because of the amount of up-front costs associated with
developing those strategies. Or when comparing Fund 8
and Fund 2 of a manager, the up-front organizational costs
and incremental management expense of Fund 8 may be
significantly less than what was needed for Fund 2. In that
instance, the investor may weigh fee structures more heavily on incentive-based rather than fixed fees.
Everything is situation-specific?
Hason: Yes, everything is very situation-specific.
Lots of talk continues about the lessons learned from
the crash and how fund fee structures have changed
in the past few years, post–financial crisis. Have people
really learned these lessons? Are the old ways gone forever, or is this just cyclical?
Gordon: There is a market for investment management
services—fees—just as there is a market for anything else.
There is a supply-and-demand dynamic, which changes
after a period of poor returns, and also an increased awareness that is going to affect the way fees look post–2009–
2010 versus the way they looked in the 2003 to 2006 era.
The report emphasizes that when one talks about fees and
private equity real estate investment management, the picture is complex and multidimensional. The ways in which
fee structures have changed will vary greatly from fund to
fund, and they’ll also vary depending on the track record
of the fund manager. As so many other things work in real
estate, the bundle of products to look at is very heterogeneous. And just as every piece of real estate is unique,
every fund offers a distinctive risk-reward bundle—not
only in its investment strategy and the properties it owns
or wants to own but also in its fees.
I think in the post-crisis era, fund fees do look a lot different; fees on committed capital are way down and catch-ups are recast and often either eliminated or reduced, just
to name two changes. But these things do go in cycles, and
as demand for LPs to get into certain funds rises, which
is happening right now, I expect that fund fees that were
offered just two years ago when it was hard to raise money
will, in time, adjust yet again. It’s a market like any other
market: it’s got a supply, a demand, and a price discovery
feature to it. This paper is helping LPs be smarter consumers in choosing a fund, particularly by helping them in that
price discovery part. Joe Pagliari’s analysis provides a better
view of how to think about that complex puzzle of fees.
Peyton: I also think a clear lesson from the crash is the
peril associated with chasing return, especially when it
involves accepting leverage as the driver. Unfortunately,
investors sometimes need to chase return because of performance targets that might be aggressive given the phase
of the real estate cycle, and that can affect the types of fee
structures they sign on for. Did everyone learn the lessons
of the crash? Well, we are starting to see people go back
to the same hymn book, right? They are signing on to the
same types of structures. And I think that the driver of that
is often their return bogeys, and those bogeys influence
the appetite for risk, and sometimes they just don’t match
You’re referring to the 7% or 8% or whatever required
returns of some investors?
Peyton: Right. That 7% or 8% does not recognize the
impact of the cycle at any particular point in time. It
can sometimes put investors in a situation of swallow-