Although net asset value is being touted as a fairer basis for management fees than gross asset value, it too can be problematic – especially during a market slump. Peter Hughes, a partner in the investment funds team at law firm Salans’ London office, points to the case of the general partner of one private equity fund, which approached the limited partners regarding a restructuring because the net asset value – on which management fees were based – had plunged so far that fees would not cover a fraction of the management costs, making it difficult to motivate individual fund managers. On the condition that the sponsor would inject extra capital, the limited partners agreed to pay a flat-rate management fee for the remainder of the life of the fund, decoupling it from net asset values.
“If they hadn’t come to an agreement there may have been no commercial alternative than for the fund to be wound up – which is the worst case scenario at the bottom of market,” explains Hughes. “So the investors had a commercial incentive to be reasonable in terms of restructuring the fees.”