How can you evaluate the impact of fees on portfolio returns?

2 Fee impact

The impact of fees on portfolio returns can be measured by comparing the net internal rate of return (IRR) and the net multiple of invested capital (MOIC) of the fund with the gross IRR and gross MOIC, which are the returns before deducting fees. The difference between the net and gross returns represents the fee drag, which is the percentage of returns that are lost to fees. The fee drag can be expressed as a percentage of the gross IRR or gross MOIC, or as a percentage of the net IRR or net MOIC.

3 Fee benchmarks

Comparing the impact of fees across different funds can be made easier with fee benchmarks, which are standardized fee assumptions that can be applied to any fund. These benchmarks allow for comparison of funds with different fee structures, strategies, vintages, and performance. Examples of common fee benchmarks include the ILPA Simplified Fee Template, developed by the Institutional Limited Partners Association (ILPA), which assumes a 1.5% management fee on committed capital during the investment period and on invested capital thereafter, as well as a 20% performance fee with an 8% hurdle rate and a 100% catch-up. The Cambridge Associates Fee Benchmark is another example, based on the average fees reported by funds in the Cambridge Associates database and varying by fund strategy, size, vintage, and geography. Lastly, the Public Market Equivalent (PME) Fee Benchmark estimates fees based on what would be paid if the fund's cash flows were invested in a public market index like the S&P 500. This benchmark includes a management fee based on the average market capitalization of the index and a performance fee based on the excess return of the fund over the index.

4 Fee analysis

To perform a fee analysis, you can use tools such as Excel or specialized software to calculate the net and gross returns of your fund and compare them with the fee benchmarks. You can also use sensitivity analysis to test how different fee assumptions affect your net returns. For example, you can change the management fee percentage, the performance fee percentage, the hurdle rate, the catch-up ratio, or the fee offset ratio, which is the amount of fees that are reduced by the income generated by the fund from sources such as dividends, interest, or portfolio company fees. By doing a fee analysis, you can gain a better understanding of how fees affect your portfolio returns and how your fund compares with other funds in the market.

5 Fee negotiation

Doing a fee analysis can offer several advantages, one of which is better fee terms with your fund managers. Fee negotiation is a process of discussing and agreeing on the fee structure and level that are fair and reasonable for both parties. This can occur during the fundraising, investment, or exit stages of the fund lifecycle. Factors influencing fee negotiation include market conditions, such as the supply and demand of capital, competition among funds, and performance expectations. Additionally, fund characteristics like strategy, size, track record, team, and alignment of interests can play a role in fee negotiation. Lastly, investor characteristics such as size, type, relationship, and bargaining power can also have an effect. Ultimately, successful fee negotiation can result in discounts or rebates that can improve your net returns and enhance your value for money.

7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?