Key Points:
- In the late 19th century, independent managers began taking charge of investing and administering capital.
- Brokers and promoters now drive the private markets, which exemplify the intermediary-driven nature of financial capitalism.
- Multiple layers of agents are active in private markets, including fund providers, fundraisers, gatekeepers, and business managers.
- Private equity (PE) firms have expanded vertically and horizontally, entering adjacent sectors and acquiring LP entities.
- Intermediaries in private markets charge various fees, and the fees in the private equity sector can be as high as 10%.
- The growing presence of intermediaries and the lack of transparency in private markets can hinder market efficiency and pose agency problems.
- The regulators who oversee the private markets may face conflicts of interest since their funding often depends on the institutions they regulate.
Capital ownership and investment management have evolved significantly over time. In the late 19th century, independent managers began taking over the task of investing and administering capital. This shift marked the beginning of the agency model of private markets, where intermediaries play a crucial role in running modern economies.
Private markets, in particular, exemplify the intermediary-driven nature of financial capitalism. The laissez-faire system has created a market environment where brokers and promoters drive the markets, shaping the investment landscape.
In private markets, several layers of agents are involved, assuming different roles and responsibilities. While the following list is not exhaustive, it provides an overview of the various participants:
| Role | Types of Participants | |
|---|---|---|
| Layer 1 | Fund Providers or Limited Partners (LPs) | Pension Funds, Insurers, Banks, Endowments, Sovereign Wealth Funds, Wealth Managers, Family Offices, Secondary LPs |
| Layer 2 | Diversified LPs | Funds of funds |
| Layer 3 | Fundraisers, Gatekeepers, Administrators | Placement Agents, Portfolio Management Advisers, Offshore Fund Administrators and Custodians |
| Layer 4 | Fund Managers or General Partners (GPs) | Funds in Private Equity, Infrastructure, Real Estate, Venture Capital, etc. |
| Layer 5 | Loan Providers | Banks, Private Debt Funds (GPs), Bond Investors |
| Layer 6 | Deal Brokers and Introducers | Investment Banks, M&A Boutiques, Accountants |
| Layer 7 | Due Diligence Advisers | Lawyers, Consultancies, Accountants, Executive Search Firms |
| Layer 8 | Business Managers | Corporate Executives, Interim Managers, Turnaround Specialists |
Private equity (PE) firms, in particular, have expanded both vertically and horizontally. Initially, PE firms went downstream to develop and push transactions, ensuring proprietary deals. However, the unpredictability of fee generation in the M&A trade led to the outsourcing and intermediation of deal origination.
PE firms also focus on captive assets held in portfolios, charging fees through the operational management of investee companies. While these fees are contractually meant to be distributed to LP investors, not all PE firms comply with these obligations.
Additionally, PE firms have moved up and across the supply chain, acquiring LP entities and expanding into adjacent sectors such as real estate, infrastructure, and venture capital. This expansion allows PE firms to access new sources of capital and generate additional fees.
Within the private markets, various intermediaries charge different types of fees. In the private equity sector, annual fees can reach as high as 10% and include fees charged by LPs, fund of funds, placement agents, GP management fees, GP performance fees, lending fees, deal brokerage fees, due diligence fees, and GP portfolio monitoring fees.
The growing presence of intermediaries and the lack of transparency in private markets can hinder market efficiency and pose agency problems. Intermediaries with little or no accountability tend to prioritize their own interests over those of their clients.
Regulators who oversee the private markets may also face conflicts of interest. The funding for regulatory agencies often depends on fees generated from the institutions they regulate. This presents a dilemma where the regulators must decide whether to protect the principals’ interests or preserve their source of income.
As the agency model of private markets continues to evolve, it is essential to consider the role of intermediaries and the potential consequences of their increasing influence in shaping the investment landscape.
