Preqin: Private Equity Funds Adopting Higher Hurdle Rates

New research from data provider Preqin suggests private equity fund managers are making efforts to align their interests with those of their investors. 

For example, new or recently raised funds are setting higher hurdle rates than in previous years, noted Preqin’s 2016 Private Capital Fund Terms Advisor. This means they have to reach higher performance targets before they can charge carried interest, a primary compensation mechanism for PE managers. 

Last year’s edition of the report found that the majority of funds (56%) were charging an 8% hurdle rate, while only 8% of funds had a higher rate, while 19% of funds had no hurdle. In 2016, the proportion of funds with an 8% hurdle rate dropped to 48% while the proportion with no hurdle fell to 13%. Conversely, the proportion of funds with a hurdle rate higher than 8% rose fourteen percentage points to 22%. 

The evidence suggests fund managers are making good-faith efforts to appeal to investors on the basis of interest alignment, Preqin said in a statement. The proportion of investors that report that their interests are aligned with managers’ has risen from 63% in June 2014 to 79% in May 2016, the highest proportion Preqin has seen, while a third of investors report that fund terms have changed in their favor over the past 12 months. 

• Fees, however, remain a recurring issue. Among those who do not believe that interests are aligned, the highest proportion (64%) cited management fees as an area for improvement, followed by transparency (47%) and the amount charged in performance fees (42%).
• Other key findings from the report:Investor Choices: The majority (53%) of investors report that they have occasionally decided not to invest in a fund due to the proposed terms, while 14% say that they frequently do so. Conversely, a third (33%) of investors report that fund terms have never affected their decision whether to invest in a fund or not. 

• Carried Interest: Despite some recent high-profile firms announcing changes to their carried interest structure, 84% of 2015/16 vintage funds and those currently in market charge a 20% carry fee. Eleven percent of funds charge a lower rate, while 5% charge a higher rate. 

• Management Fees: Although the median management fee charged by buyout funds has stayed at 2% for the past ten vintage years, the mean has steadily fallen. For 2015/16 vintage funds and those raising, the mean management fee is 1.78%, down from the 1.99% average seen among 2010 vintage funds. 

• Fund Sizes: The largest buyout funds charge the lowest management fees on average, and are seeing fee rates decline further in recent vintages. Peaking above 1.80% for 2010 vintage funds, the mean management fee for buyout funds of $1bn or more is now 1.53%, the lowest rate seen in ten vintage years. 


“In negotiations over private capital fund terms, the balance of power has shifted notably towards investors over the past decade,” observed Selina Sy, editor of this year's 234-page report. “There have been several recent instances of investors putting pressure on fund managers to adapt their fee structures, and it appears as though many managers have taken note.” 

“Investors will be pleased to see that there has been such a notable shift towards higher hurdle rates among more recent funds,” she added. “Given that many public equity markets are seeing minimal growth in investor capital, it is a mark of fund managers’ confidence in their ability to provide non-correlated returns for investors.”

Preqin has been tracking the private equity markets since it was founded in 2003. The firm is a leading source of information for the alternative assets industry, providing data and analysis via online databases, publications and bespoke data requests. More than 40,000 professionals in 90 nations use the company’s products.