David Rubenstein: evaluation

Transcript context

…Private equity has been growing for quite a while now, more so than most kinds of finance have been growing. And the fee structure of 2 and 20 — where does the 20 come from? And why isn’t the 20 declining more rapidly? Well, it is in some respects. Let me explain. First of all, the market — and you are a market economist — people are getting 2 and 20 because that’s what the market will say is appropriate. It’s not as if people are being pushed or forced into paying people 2 and 20. Nobody’s being forced to go into these funds. Where does the 20 percent come from? I’ll give you two examples of where it may have come from. When Venetian ship owners would send their ships to Asia to get spices, the spices would be brought back in the ships, and those who brought them back, who carried them back, had an interest in the profitability of the spices when they were sold back in Venice. They had a carried interest, in effect, and that was roughly 20 percent. That may be where that came from. But also, when the first hedge fund was set up in the late 1940s, the person who set it up actually said, “I’m going to add value. I’m going to do more than just manage it. I want a percentage of profits. I want 20 percent.” When the first venture firms were set up in the ’50s and ’60s in Silicon Valley, they also had professionals who said, “I’m going to add value. I want 20 percent of the profits.” It’s amazing that, for all these 50, 60 years later, 20 percent has still stood the test of time. Obviously, some people have higher venture capital, sometimes will have 30 percent, and some people, to get in the business, may have 15 percent, but by and large, 20 percent is still more or less the rule. I would say 2 percent is probably not as common as it used to be, unless it’s a small fund. For a large fund, it would probably be 1 percent or 1.25 percent or maybe 1.5 percent and 20 percent. If we look, say, at mutual funds, there’s a lot of entry, and the cost of intermediation falls, through Vanguard, Fidelity — lower cost than what there used to be. What’s the barrier to entry in private equity that keeps that number at 20 percent?…

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