Private equity investors ‘questioning the economic model of fund management’

_{Bart van Dijk, Head of Europe, and Jennifer Choi, CEO, ILPA}

Jennifer Choi is CEO and Bart van Dijk is Head of Europe at the Institutional Limited Partners Association (ILPA). It engages, empowers, and connects more than 600 member organizations globally, representing approximately $3tn of private equity assets, to maximize their performance on an individual, institutional, and collective basis.

Jennifer joined ILPA as Managing Director, Industry Affairs, in 2014 and became CEO in 2022. Bart joined in October 2024 to lead the association’s European efforts from its new London office.

Shaun Beaney, Editor of Preqin First Close, and Grant Murgatroyd, Head of Preqin News, asked them about the current challenges for investors, the future of US regulation, transparency, valuations, and expanding in Europe.

Shaun Beaney: What are the biggest challenges for ILPA’s members right now?

Jennifer Choi: Broadly speaking, the challenge for members at this particular point in the cycle continues to be the lack of distributions, or distributions that fall below historical patterns and pace. What does that mean for their ability to put new capital to work, to pursue exciting opportunities? What are the prospective returns from their private equity or private capital investments more broadly? And where do these strategies fit into their future allocations? Longer term, I think there continues to be a gap between how LPs and GPs come together to set the foundation for the partnership. Where that manifests is in the limited partnership agreement (LPA), in fund terms where there are opportunities for even stronger alignment, because these are very long-term relationships that span well beyond the proverbial 10 years. Often, they straddle decades and multiple funds.

Grant Murgatroyd: On fees and terms alignment, are there any specific areas where people want to see change? For example, when Preqin surveys LPs, the quantum of fees is not necessarily as much of an issue as structure and transparency are.

Jennifer: The principle is that most of the economics should reside in the carried interest rather than fees. As an alignment mechanism, that structure works very, very well because it's tied to the fund’s performance. But the broader trend we've seen is a migration away from things that used to be covered by the management fee and are now being charged to the fund as a partnership expense. And, moreover, some of these fees relate to things that are being executed by the internal staff of the GP. So, theoretically, you'd imagine this would have been covered as part of the overhead that falls within the conventional idea of a management fee. The partnership expense provisions of the LPA have gone from a few paragraphs to several pages. That's often characterized as an articulation of practices that have been in place for a while, but in effect, this translates to visibility into a greater share of costs that are borne by LPs. I think LPs are understandably questioning the economic model and whether it really is still anchored in that principle of alignment and mutual success over the life of the fund. That's where LPs are spending more and more time.

GM: Are there governance terms on which LPs are focusing their attention?

Jennifer: Key person provisions are one area of LP focus because they’re so intrinsic to the partnership. When an LP goes into a fund, they’re doing so because of a belief in how that fund is going to be managed and led. So, knowing that you’ve got real conviction in the leadership of the fund, that there's continuity, that there's team cohesion, is really critical. When there is a key-person event, it’s knowing with absolute clarity how it's going to be managed, how it's going to be communicated, what it means for the management of the fund, suspension of the investment period, etc. Key person is one that LPs continue to put consistently in the top three governance items that they're really focused on.

SB: Panning back a little, what are ILPAs top priorities in public policy, legislation, and regulation?

Jennifer: I would start by ensuring that we can preserve the regimes that exist to provide investor protections to LPs in private funds. We don't have a crystal ball, so can’t know exactly what's coming next in US or Europe vis-à-vis these sorts of investor protection regimes. But it’s a priority. We've certainly learned over the last decade how important it is that there is a regulatory entity that has visibility into how the relationship between the LP and GP is being managed in the context of the contract. Not only how the contract is being honored, but also where there are issues that transcend the contract. These are things that LPs would not be privy to but that speak to conflicts of interest and disclosures – or, at the extreme – to fraudulent behavior. It’s important that there is someone who’s in a position to see those things as they happen and to flag them for action.

Sustainability is another area where ILPA is keeping a watching brief. We’re continuing to track how different disclosure frameworks and regulatory regimes evolve. These regimes can certainly help LPs by giving them a construct to put more capital to work around sustainability. But they could also be restrictive in certain contexts, if there are narrow definitions of what constitutes something that is sustainable or not - or by contrast, if there are guardrails imposed around an LP’s ability to consider certain risk factors. LPs want clarity, they want certainty, they want consistency, and they want appropriate levels of discretion in how they carry out their fiduciary duty. And I think GPs would say the same.

Bart van Dijk: It's really important also for GPs with LPs to make sure, at the end of the day, that there's a true business case or value addition in being sustainable, in focusing on ESG – that it's not just a story.

SB: Earlier this year, US appeals court judges struck down the Private Fund Advisers Rules by the Securities & Exchange Commission, which were intended to boost transparency, competition, and efficiency for investors. How does ILPA view the role of the US regulator?

Jennifer: It's challenging to know exactly what the incoming commissioners and chair of the SEC might do differently from their predecessors. We know that more broadly in the US there's likely to be a deregulatory agenda. The Fifth Circuit Court of Appeals provided a pretty definitive answer on whether or not the SEC has the remit to do anything beyond what they're currently doing, and we also saw a very clear signal from the industry more broadly that litigation as a reaction to regulation in the US was likely to become more commonplace. That said, the SEC's mandate to examine and oversee private funds under the Dodd-Frank Act holds.

Private funds continue to feature in the SEC’s priorities as a critical aspect of how they're carrying out their three-pronged mission. We expect that examinations will continue. We expect that SEC staff will continue to look for things like whether there's been adequate disclosure of practices, adequate calculation and application of fees, and how those costs are shared between the GP and the fund. We expect there will continue to be an assessment of compliance with federal statute and securities laws.

The specific changes proposed in the Private Fund Advisers Rules obviously won't feature. But we should not expect there to be a stepping back by the SEC in the mandate that they have today.

GM: What about valuations? Are you seeing any serious demand from LPs for ways of making those more transparent?

Jennifer: I think that the call for transparency around valuations is largely around methodology. When you consistently see a big pop on exit, LPs are very much looking at how you’ve held that asset over two quarters, for example, leading up to the exit. What sort of a premium should you expect? LPs really want to understand the GP’s thought process. If you’re holding something at cost, what is the thesis behind holding it at cost, and for how long? What are the tools you’re using to generate those valuations, vis-à-vis actual deals that are being transacted today? LPs want a NAV that's as accurate as possible, knowing that there's going to be movement on realization. The challenge is that we don’t have a hyper-accurate signal from the market, because the deals that tend to be transacting in the current moment are the highest quality assets.

GM: Do LPs have a particular view on continuation funds? They always seem to be prefaced with the word ‘controversial’.

Jennifer: It's an evolving view. LPs are coming to different conclusions on continuation vehicles (CVs). We always go back to first principles: if it’s a high-quality asset, why is this the best path to exit, as opposed to a clean or a conventional exit? If you're transacting on the CV early in the fund’s life, why? Why not let it stay in the fund a bit longer? And provided GPs have good answers to these questions, I think LPs can get comfortable. (Read ILPA’s industry guidance here.)

SB: There’s concern among some regulators and LPs about the growth of NAV-based facilities, which the Fund Finance Association forecasts could be worth $600bn by 2030. What’s your perspective?

Jennifer: As you'd expect, we always start with transparency and alignment of interest. It’s a recent phenomenon that these facilities have really become much more commonly used tools in the marketplace. Before, there wasn't a proactive conversation taking place. LPs were discovering that these facilities were being taken out and secured by the underlying assets in the fund. That's always problematic because part of the risk picture that LPs need to build and then monitor over the life of the fund is overall leverage, and leverage relative to whatever contractual guardrails have been imposed through the LPA. It’s sparked a more transparent conversation between LPs and GPs: What are these? Why are they being used? What is the use of proceeds? What do they cost? What are the covenants? What does this mean for the funds, the cost to the GP and the LP, and any additional risk imposed by utilization of the facility? And why this, as opposed to alternatives? It doesn't prejudge that this is not the right choice, but LPs are, again understandably, asking these questions.

Where the LPA says nothing about NAV facilities – and the vast majority do not – LPs and GPs are trying to get to a sharper understanding of whether they belong within the borrowing provisions. Do these NAV facilities sit under the fund’s structure or not? That in turn tells you how to interpret the borrowing provisions. I'm happy to report that there's more dialogue going on and it’s much more open. And we’re seeing GPs increasingly consult their LP advisory committees on this topic, in line with ILPA’s guidance, which emphasizes the importance of dialogue and transparency.

SB: ILPA represents pension funds, endowments, foundations, family offices, insurers, investment companies, development financial institutions, and sovereign wealth funds. How do you find common ground across such a diverse membership?

Jennifer: I would start by acknowledging that even though conventional wisdom tells us that LPs group by type of institution, if you dig a level deeper, I think you see commonality across vectors that are different from just institution type. There’s some patterning happening with small LPs compared with large LPs, public LPs compared with private LPs, mature programs compared with growing programs, and globally diverse compared with regionally concentrated. But I find that when we bring our members together, there's a surprising amount of consistency around the things that truly matter, the things that are in ILPA's DNA, such as transparency.

Bart: When we reach out to and engage with our LP members, with the community, we also look at the broader commonalities, from a content point of view, and also in subsets according to type. So, if there’s any nuance in the specific institute type, then we would pick it up from those subsets of conversations we’re having with our members as well.

Jennifer: We’re surprised sometimes how often the same things keep coming up in discussions with members in completely different parts of the world. Continuation vehicles keep coming up. Co-investment keeps coming up. NAV facilities keep coming up. Distributions and the impact on pacing and future commitments. You’re likely to see a lot more of the nuance when there’s something about the local market dynamic, regulatory or otherwise, that impacts how they approach the private markets.

SB: You’ve opened a London office, alongside your offices in Washington and Toronto. What are your aims for ILPA in Europe?

Bart: Europe is a combination or a conglomerate of various distinct countries and regions, and in that sense, it’s obviously different from North America. We have sub-regions that are very important in this LP community, but it's also about engaging with the ecosystem. We’re trying to be closer to the regional ecosystems within Europe, and make sure that we have deep conversations with our growing community of members, partners, and industry players about the most relevant global topics as well as the local regional ecosystem matters that are equally important. We’re continuing to scale into a global organization. And to do that, we're reaching out to ecosystems and subsets regionally, but also in specific countries and jurisdictions where LPs are concentrated.

We already have approximately 20% of our membership in Europe, so 120-plus members in Europe right now. The UK, Nordics, Benelux, France, and DACH all require our deep engagement. And fund jurisdictions, which I define as ecosystem hubs, are very important from an interconnection point of view – obviously, Luxembourg, Ireland, the UK, Channel Islands, and the Netherlands. It's the engagement. It’s the growth. And it’s the global to local.

Grant Murgatroyd is Head of News at Preqin and Shaun Beaney is the Editor of Preqin First Close. You can read all our latest coverage and free reports here. It’s quick, easy, and free to subscribe to our newsletter here.

Preqin is an ILPA partner organization. Special thanks to Megan Goodman, Director of Strategic Communications at ILPA.

_{The opinions and facts included within the above do not constitute investment advice. Professional advice should be sought before making any investment or other decisions. Preqin providing the information in this content accepts no liability for any decisions taken in relation to the above.}