Pantheon chief: Lower return expectations could pressure fees

  • “You have to make sure it’s fair and reasonable,” says Swire
  • Lower inflation translates to a lower base rate of acceptable returns
  • Pantheon founder bullish on infrastructure

A decade of low or non-existent inflation lowered the bar for private equity returns. General partners and investors should prepare accordingly, Pantheon founder Rhoddy Swire told the audience at PartnerConnect West 2016.

“When I started, inflation was 12, 13, 14 percent. When you’re doing well, you’re going to make 25 percent compounded,” Swire told the audience shortly after accepting a lifetime achievement award. “We’ve got to readjust to a lower base rate from the point of view that, actually, 5 percent real is a decent return.”

Swire’s comments echo a growing chorus of private equity market participants arguing the industry’s returns may fall as general partners deploy capital in an increasingly unfavorable deal environment.

In September, Andrea Auerbach of Cambridge Associates said she was “nervous” about the high prices firms pay for new assets. Earlier this month, investment advisory firm Verus signaled its bearishness on the U.S. buyout market, citing downward pressure on buyout returns as managers load more equity into their deals. Blackstone Group’s Joe Baratta called the deal environment “the most difficult period we’ve ever experienced,” according to Bloomberg.

According to Swire, declining returns could cause fund investors to pressure private equity firms and other alternative asset managers to reduce fees. Private equity firms derive their management fees from the amounts limited partners commit to a fund, earning income from those fees regardless of performance. So, even as returns fall, fund investors pay the same dollar amount for diminished returns.

In the early 1980s, around the time Swire launched Pantheon, funds collecting a 2 percent management fee on committed capital often generated internal rates of return in excess of 25 percent, he said. According to Cambridge Associates data, the median IRRs for mature buyout and growth equity funds raised in 2006 was 8.47 percent.

“Those are the dynamics one has to come to grips with. You have to make sure it’s fair and reasonable,” Swire said. “If you upset your investors, it tends to not be repeatable.”

Alternative structures

While Swire cautioned GPs about investor concerns around fees, he also attributed some of Pantheon’s success to his decision to charge management fees off the amount LPs commit to his funds, as opposed to the amount ultimately invested. Many limited partners favor the Pantheon’s model.

Swire launched Pantheon in 1982 and shepherded the $33 billion asset management firm through multiple economic cycles. He does have at least one regret, however.

“[One] thing I got wrong is we give our money back to the clients. You know, it’s a little unfortunate,” Swire said. “There are companies out there I wish we could have owned for much longer than we did, but that’s life and you have to move on.”

Most of Pantheon’s investment vehicles are traditional closed-end funds that must wind down their holdings after a certain period, usually between 10 and 15 years.

The firm operates one permanent capital vehicle, Pantheon International, which had around $1.3 billion under management, Swire said. Pantheon International was launched in 1987. Its shares are publicly traded on the London Stock Exchange.

The vehicle typically invests through the secondary and co-investment market, and its holdings include funds managed by firms like Bain Capital, Kohlberg Kravis Roberts & Co. and Summit Partners, according to its website.

Pantheon International also allows the firm “to take longer term views. Not for a great percentage, but for a bit,” Swire said, adding that the International Fund has grown at a rate of 11.7 percent for the previous 29 years. The fund’s NAV per share grew by 22 percent during the fiscal year ending June 30. “We’ve had a good stab at that.”

In addition to building out the permanent capital fund, Swire also sees opportunities in infrastructure assets, which typically offer a lower return, but with reduced risk and over a longer time horizon.

Pantheon closed its latest oversubscribed infrastructure fund on $1 billion in March 2016. The firm is using the fund to acquire secondary stakes in infrastructure assets, in addition to occasionally making primary commitments and co-investments as well.

“This fills a need because they can actually produce an income, and income is scarce,” he said. “It’s been mammothly needed here, Asia, Europe in order to build the infrastructure that great societies have come to demand.”

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Photo by Buyouts staff