Scandals, Bans Fail to Slow Placement Agent Boom

Despite bad publicity, official bans, and even criminal convictions, placement agents have become more rampant than ever in institutional investing, according to a new study.

From an examination of placement agent investments from 1991 to 2011—covering 32,526 investments in 4,335 private equity funds—the study found an overwhelming uptick in the use of intermediaries.

While placement agents were virtually absent in 1991, nearly 75% of private equity funds relied on them in 2011, wrote Matthew Cain of the US Securities and Exchange Commission, Stephen McKeon of the University of Oregon, and Steven Davidoff Solomon of the University of California, Berkeley.

While placement agents were virtually absent in 1991, nearly 75% of private equity funds relied on them in 2011, the study found.Specifically, investors in the Netherlands, Norway, and Denmark employed placement agents more than 50% of the time, while only 18% of US asset owners used them.

But are these matchmakers truly helping limited partners (LPs), the authors questioned, or are they simply “influence peddlers” that attract investors through “personal relationships, aggressive marketing, or worse, kickbacks and ‘pay to play’ schemes”?

“Placement agents can create value for LPs if they are able to discern fund quality ex ante, thereby mitigating information asymmetries and reducing search costs for LPs by certifying high quality funds,” the authors said.

However, these potential benefits—in the form of strong fund performance—manifested in funds brought in by top tier agents and first time funds.

Generally, funds employing placement agents underperformed the market by 350 basis points, the authors found. Furthermore, 20 largest investors studied in the research reported 6.7% lower net internal rate of returns for investments in funds that used placement agents.

These low returns could be caused by agents working as “little more than hired guns acting out of self interest to market any fund willing to pay them,” Cain, McKeon, and Solomon said.

In addition, the study found a close relationship between an asset owner and agents could be particularly damaging for investors. When an LP invests with a single placement agent, the authors said, returns tended to suffer as the agent screens funds less strenuously.

In the 20-year period in the study, only three agents had exclusive relationships with a pension fund: Arvco Capital Research, Wetherly Capital, and Diamond Edge Capital Partners—all of which have been indicted on criminal charges of pay-to-play, according to the research.

Read the full paper here.