Apollo Agrees to Cut $125 Million in Fees for CalPERS

In the aftermath of the financial crisis, the California Public Employees' Retirement System (CalPERS) and its largest investment partner, Apollo Capital Management, have reached a new agreement on fees.

Over the next five years, Apollo will reduce its fees by as much as $125 million. Additionally, the firm will no longer be able to use the services of placement agents, who help raise capital for new funds. The main reason for the latter change is a concern over possible conflicts of interest after a former CalPERS board member made $59 million in commissions as a placement agent.

Given the size and influence of CalPERS, this deal will be scrutinized carefully in the alternative investment industry and likely to be a template for other negotiations.

The New Balance of Power

When private equity was surging between 2002 and 2006, there was little concern about fees from limited partners, the investors. These players include large organizations like endowments, insurance companies and pensions.

As a rule, the fees were hefty. The typical structure included a 2% management fee as well as 20% of the profits from the fund, called the carried interest. It was a recipe for making some private-equity investors rich.

Of course, this sentiment has changed over the past couple years as the markets have undergone extreme volatility and many private-equity firms have sustained losses. Moreover, given that some funds still managed large portfolios, the fees were still generating significant earnings. The main reason was the management fee. For example, a 2% fee on a $10 billion fund is a cool $200 million per year.

As a result, a group limited partners created an organization called Institutional Limited Partners Association and have set forth principles on key areas like fees, taxes, disclosure and contractual rights.

Private-Equity Headwinds

The pressure on fees is not the only problem facing private-equity operators. First of all, it it is getting much more difficult to raise capital and it is harder to get liquidity on deals, even though the IPO market is starting to perk up. Next, Congress is seriously looking at increasing the tax on carried interest, which is currently at a relatively low 15%. The hike is expected to result in as much as $24.6 billion in additional tax revenues over the next ten years.

Next, some limited partners are even looking at ending their commitments for providing additional capital to funds. This would certainly add to the pressure on private equity firms.

As for Apollo, the firm had little choice but to give in. Even so, it was successful in limiting the damage: the reduction in the management fee was only 0.2% and there was a drop of 1.3% for the carried interest. It helped that Apollo had a strong 2009 and CalPERS has a 9% equity interest in the firm. In fact, this new deal is being called a "strategic relationship agreement."

But reductions will be the norm for the private-equity space. CalPERS is evaluating many other firms, including Goldman Sachs (GS). In light of Goldman's recent bad publicity and fraud charges from the Securities and Exchange Commission, this is certainly a decision that is eagerly anticipated.