5 minutes with… Colmore
The latest instalment of our ‘5 minutes with…’ series; a brief catch-up with private equity operational professionals and service providers to learn about their work and views on current trends.
Fee validation is fast becoming a hot topic. As private equity mature it is moving towards more granular reporting, but significant fines handed out to larger players has put the onus on LPs to question the figures provided by their fund managers. With many lacking resources, know-how or simply manpower, a new market has opened up.
The Drawdown recently caught up with Alex Tarantino, commercial director at Colmore, an independent service provider that spun out of Capital Dyamics two years ago, to talk fee validation.
The Drawdown (TDD): Why do you think validating fees has become such an issue for LPs of late?
Alex Tarantino (AT): The industry is undoubtedly moving towards greater cost and fee disclosure by GPs. This first started with the SEC’s “Spreading Sunshine in Private Equity” report a few years ago, which found “material weakness” in the allocation of fees and expenses in 50% of GPs they evaluated. Since then, there has been several high profile cases of GPs misallocating fees to investors, resulting in regulatory fines and penalties. This has prompted LPs to take a closer look at their managers and demand more transparency and disclosure within the asset class.
Separately, in the US, the concern around investment costs has led to many States’ legislators passing laws that require public LPs to specifically disclose fees, expenses and carried interest paid. These public LPs are therefore faced with two questions: how do they aggregate all of this data, and how do they ensure that the fees they report are correct? There is a significant risk to reporting incorrect or unvalidated numbers. The solution therefore is to establish a fee validation process internally, which usually requires dedicated resources, or to engage a third party provider like Colmore to report and validate on their private asset portfolio.
TDD: With a number of service providers popping up to solve this issue, do you think this could be a sign that LPs are becoming more vocal in holding their fund managers to account?
AT: LPs have a fiduciary duty to implement reasonable measures to identify and prevent miscalculations. LPAs can be vague and subject to interpretation, and have complexity built into how fees and incentive allocations are calculated.
TDD: What service does Colmore offer for fee validation?
AT: Colmore developed its fee validation service offering, called FAIR (Fee Allocation Incentive Reporting) to provide an extra layer of transparency and assurance for investors in private assets. FAIR enables investors to better understand the fees and costs associated with investing in private assets without the financial costs and resources required to undertake a financial audit. The Colmore FAIR programme seeks to achieve three key objectives for investors:
- Provide an accurate reflection of fees that they are paying through their private assets portfolio.
- To confirm that the fees they are being charged are in line with the terms outlined in their LPAs and any side letters.
- To benchmark the fees they are paying against the wider private asset industry.
TDD: Can you shed some light on the process Colmore undertakes when validating fees for its clients?
AT: Colmore uses information provided by general partners via quarterly and annual financial statements, cash flows, capital account statements, etc. to model expected management fees, expenses, and carried interest and compares these to actual figures reported by the general partner.
Variances between expected and actual are then analysed. Based on predetermined risk thresholds, which are agreed with the LP, we provide an overall fund score. This score provides a quick reference point for each fund, backed up by detailed analysis. Clients are then able to see how one fund compares to another on a consistent, repeatable basis.
TDD: How does Colmore differ from other service providers?
AT: We provide a pragmatic solution to fee validation. It’s an ongoing, rather than point in time service that gives investors confidence. Forensic analysis of a specific quarter is great, but what happens in the next quarter, or six months later? Ongoing analysis gives you specific quarterly assurance and also enables trend analysis. In long term investment funds, this is critical. Our approach also respects the GP/LP partnership: We aren’t looking for a GP “gotcha”. We’ve developed a unique scoring mechanism which enables investors to see at a glance where there may be concerns or areas to discuss further with GPs. The analysis is all delivered through our online portal, meaning reports can be accessed anywhere at any time.
We work from the existing documentation the GP provides the LP. We are not intrusive. Our goal is not to burden the GP with new reporting or template requirements. Where we find discrepancies, we have the expertise and tact to help rectify anything we might find directly with the GP.
It is important to note that we are not only looking for overcharges, but also proactively identify cases where the GP might have undercharged the LP. We have seen other service providers approach fee validation as a debt recovery type of exercise, where the service provider’s fees are aligned to the amount they recover. We believe this is misaligned, and does not respect the core partnership that GP and LPs engage in.