Are hurdle rates too high for the current environment?
It’s never a bad idea to rethink incentivisation models in the interest of LPs’ returns.
By Adam Le
The merchants of Venice were clever people. Not only did they give the world innovations such as the concept of quarantines, double-entry book-keeping, the modern navy, casinos and opera houses, they are also credited by some accounts to have given birth to private equity’s 2 and 20 model.
Underpinning a manager’s ability to reap one-fifth of profits is the hurdle rate – which, readers won’t need reminding, is typically set at an 8 percent return. At various points in the history of the private equity industry, certain managers have sought to adjust this rate; in some cases they’ve done away with it altogether. Advent and CVC are examples of firms that have either lowered or gotten rid of hurdle rates in the past.
Received wisdom is that as interest rates rise, hurdle rates should too so they can reflect the performance private equity is expected to deliver over and above risk-free assets such as government bonds. Yet as we approach the end of 2023, the opposite appears to be happening. Research published this week by law firm Dechert shows...
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Founder @ XTAL | Private Market Fintech | Forward Liquidity
1 年I have heard from seasoned investor a different story John Gilligan. As the asset class is born with an absolute return cut, it needed to beat cash rates. The start of the libor time series for both usd and gpb in the 1980's was incidentally 8%. A tough rate to beat on a time weighted basis, more easily in IRR terms. As rates have progressively gone down, the 8% irr hurdle has not been a major issue.
Educator, Advisor & Impact Investor
1 年Hurdle rates are at 8% because, broadly speaking, that was the return from investing in US quoted equities in the last century, regardless of inflation, base rates or other risks and rewards that affect that return. To change it you therefore need either market power - VC for example, or as described Advent and CVC, a menu offering - some funds offer fee/carry mixes with various fees/hurdles allowing LPs to select (they almost all reportedly choose 8/20), or to explain in a convincing way to a market that isn't really listening, why the very long term returns on equity have materially diverged from that benchmark in this century. The hurdle pre-dates PE by a few centuries, so my guess is it is pretty sticky.