Managers Face Profits and Pitfalls in Long-Life Funds
By Tom Stabile
March 2, 2016
Blackstone Group, Carlyle Group, and CVC Capital Partners are already pulling in big dollars for their new long-dated funds, which at 15 to 20 years in length are the investment arena’s equivalent of an ultra marathon. But these managers – and those that follow in introducing vehicles that go beyond the 10 to 12-year length of standard private equity funds – may encounter challenges ahead in terms of the number of deal prospects and potential clients the model can support, and what might be a meaningfully different investment approach.
Carlyle Group has already raised $3 billion for its global partners fund from big institutional investors, and it is still raising more capital, said CEO David Rubenstein during the company’s recent fourth quarter earnings call.
“[W]e think there are a number investors with whom we are in discussion now that are likely to add to that sum,” he said.
CVC is nearing a close on its $5 billion version, which aims for a 15-year lifespan and targets returns in the 12% to 14% range, according to a person familiar with the effort. Like its peer funds, investors in CVC’s fund are paying lower fees than the rates for standard private equity vehicles.
Blackstone has yet to reveal the current size of its “core private equity” effort, which it began introducing to investors as a concept in 2014, but it plans to close the first version this year, said Tony James, president and COO, during the company’s recent fourth quarter earnings call.
“We’ll finish the fundraising early this year and you should start to hear more about it… later this year as we start to do the first deals,” he said.
The rise of long-dated funds is a sign of a maturing asset class, says Sanjay Mansukhani, head of U.S. private equity at Willis Towers Watson, a global investment consultant.
“It’s a natural evolution as people look around and see private assets are expensive around the world,” he says.
The main driver for the new funds is the familiar refrain of private equity investors who lament when their fund managers sell attractive assets, Mansukhani says.
“Investors are saying, ‘There are some companies that deserve to be held longer,’” he says. “‘Why sell it?”
Most investors that grumble of course know well that managers usually are compelled to sell assets that are paying a nice dividend because “they have to,” says Joe Silver, managing partner of EdgeLine Capital Partners, a placement agent firm. “It’s the 10-year lockup model.”
Investors also see longer-dated funds as a way to cut down on the standard private equity model’s constant flow of cash distributions from liquidated funds and new commitments of that money back into the asset class, Mansukhani says. “That reinvestment cycle is a big deal for plan sponsors,” he says.
That has led not only to investor interest in long-haul vehicles, but more appetite among fund managers as well, says Jeff Eaton, head of worldwide origination at Eaton Partners, a placement agent firm, in an e-mail. “We see more and more [fund managers] wanting to raise this kind of capital,” he says.
Indeed, a recent survey of fund managers from the Private Equity Growth Capital Council and EY found that 64% of managers with more than $20 billion in assets plan to increase their “involvement” with longer-life funds of 15 years or more over the next 12 months.
In the same survey, only 5% of firms with less than $20 billion expressed similar interest. But long-dated funds should not just be for the bulge bracket firms, Mansukhani says. They can also work in funds that target middle-market companies, where a few managers are already offering their own versions, he says.
“As fundraising becomes harder, we might see more firms looking at this model,” he adds.
Even if more managers introduce long-dated funds, however, there is little consensus yet on the opportunities and risks ahead. One open question is the potential target audience.
The most likely prospects for a double-length private equity fund are investors with “more mature portfolios in private equity and more knowledge of the market,” Silver says.
The model probably won’t be too appetizing to fund of funds managers that would have difficulty plugging a long-dated structure into a product built with funds of more standard length, says Bill Dahab, director of research and principal at Dahab Associates, a consulting firm.
The audience might be “largely limited to family offices, high-net-worth investors, and sovereign wealth funds,” Eaton says.
But Carlyle’s Rubenstein said the manager plans to aim for a broader audience, noting that with the “very large sovereign wealth funds, international pension funds, public pension funds in the U.S. that are interested in this, I suspect over a period of time you’ll see a broader array of investors” following suit.
Another question is what skill sets such longer life funds will require. Managers concentrating on companies worth a longer hold should be building a deals team that can identify private companies with a long-term market edge, adequate governance, and strong management, Mansukhani says. “Shorter date companies within the mix should be few and far between,” he adds.
Managers also should develop operations teams that can blend the best of standard private equity – the ability to add value and provide assistance to private companies – with a “slightly softer touch” in terms of executing changes, Mansukhani says. Many of the same tasks – such as helping with pricing strategies or making acquisitions – would be in the mix, but with “not as intense” shifts in the business, he says.
Fund managers should also be aware of risks in the model, Mansukhani says, particularly around the possibility they can lose sight of what helps standard funds deliver returns: the “urgency” to make needed changes in a portfolio company. The “finite timeframe” of standard funds requiring disposition of an asset within a five-year window, as well as the terms of debt used to leverage the investment, help create pressure to act, and without it a long-dated fund manager might become passive, he says.
“There has to be a time where there is some sense of urgency to create the value, but when should that come?” he says.
Another risk is finding enough portfolio companies that are worthy of a long-dated investment, Mansukhani says. “There’s not enough capacity for everyone to do this,” he adds. “There are not a huge amount of private companies that meet this calculus of a defensible long-term model not subject to fads and trends and technological obsolescence.”
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