A joint research paper between Harvard University and Stanford University concluded that there is a large variation in net-of-fee performance across public pension funds investing in the same private equity fund.
The paper finds a 500 basis point standard deviation on investment performance, ultimately costing public pension funds an aggregate $45 billion in the absence of a uniform distribution waterfall.
“The pattern of strong pension effects indicates that some pensions have systematically paid higher fees than other pensions in their respective funds over the course of our sample,” the research says. “We argue that this empirical finding is due to ex-ante differences in willingness to pay for the same fund.”
Pensions that are larger and bear more assets under management, have more member representation on their boards, and who are better informed about fund management (general partner) skill than others, may bear witness to some of these relatively higher net-of-fee performance figures.
There’s also the potential explanation of some GPs offering several different contracts for the same fund. For example, one contract offered to investors may include high carry fees paired with low management fees, and another might offer low carry and high management fees. The performance of the fund’s assets themselves would then lead to a wide disparity in returns due to the fund structures.
“There are consistent winners and losers in the sense that some pensions systematically pay more fees than others even when investing in the same fund (i.e., pension effects),” the report said. “The pension effects that we estimate are large in the cross-section, as some pensions could have earned as much as $15 more per $100 on their investments over our sample.”
Their research also states that GPs may do their best to exploit the differences in investors’ appetites for fee structures—and labeled it price discrimination. “In practice, willingness to pay might be revealed through negotiations or by offering LPs a menu of fees from which to choose. Our analysis collectively suggests that price dispersion of this kind is large in the context of private markets and is at least partly driven by pensions that fail to fully optimize when choosing their fee structures,” the report said.