A number of large private equity managers are straying from the asset class's traditional 10-year fund model in favor of longer-term vehicles.
With a bullish fundraising market, a burgeoning secondaries market — where firms and investors can buy and sell existing commitments in private companies and funds — and competition for deals peaking, conditions look positive for this type of fund structure. Blackstone Group LP, CVC Capital Partners Ltd., Carlyle Group LP and KKR & Co. are among firms that have set up vehicles that look to invest with a longer time horizon. Core Equity Holdings and Cove Hill Partners LP, first-time funds with long-duration strategies, raised over $1 billion each on their closes in 2017.
As a percentage of funds larger than $1 billion, long-dated funds accounted for about 4.4% of the buyout and growth capital raised since 2015, according to a 2018 report from French business school INSEAD. Of the total raised for long-dated funds, 85% was raised by multiproduct private equity fund managers, and the remainder was raised by relatively new independent, long-term-only general partners.
Long-term fund strategies could eventually represent 10% of the private equity market, a managing director at a private equity firm that has a long-duration fund strategy said. There is a rich opportunity set in businesses that do not fit into the traditional private equity fund model — whether because they are uncomfortable with the idea of an IPO or a trade sale in three to five years, or a founder is looking to turn the business over to someone else and is looking for liquidity today.
Bain & Co. researched the number of businesses that have been owned by at least three successive private equity firms to gauge how many companies might fit a long-hold strategy that would look to own assets across a similar time period. It found that in the past 20 years, over 500 companies globally matched this profile.
The managing director also noted that there are about 9,500 businesses that do not have public or private equity backing. Further, secondaries make up 30% of exits. If direct investments made by limited partners "that are held almost in perpetuity" by some large investors are included in the calculations, the figure may be higher.
The long and the short of it
Long-duration funds provide investors a number of unique benefits. Although long-duration strategies can target lower returns in comparison with traditional buyout strategies, they provide consistency. In the current bullish fundraising market, managers are coming back to raise new funds more quickly — as quickly as every two years versus the more traditional four and a half to five years — which can create reinvestment risk, Mounir Guen, CEO of private equity advisory firm MVision, said. This quicker pace means investors may not know whether managers are consistently performing across funds. Long-duration funds can solve this problem because investors know the funds are targeting a certain return across a 15- or 20-year period.
Larger investors in particular back long-term funds because they are looking for consistent returns. Investors also have allocation targets to private equity, but there is a limited number of funds that both fit larger firms' investment profiles and that they have access to. "That's why a lot of them have direct [investment] portfolios: because they just can't put enough money to work," Guen said.
Long-term funds also provide an alternative to secondaries transactions for investors. Some investors do not want to be in and out of the same assets through different funds, Michael Halford, Goodwin LLP's head of private investment funds for Europe and Asia, said, and some managers are also taking it "one step further" by creating permanent capital vehicles.
However, despite the growing interest, long-term funds are far from commonplace in private equity, and many managers remain cautious about dipping their toes into the longer-duration waters, private equity professionals told S&P Global Market Intelligence. There are a number of issues to untangle when setting up and pitching a long-term fund to investors.
Certain precedents that have been set around setting up private equity funds are "almost non-negotiable," including duration, the managing director said. Some investors like the sprint of a three- to five-year holding period, and the well-known return incentives that come with it.
Halford said he has not seen a huge number of these funds, but, he added, as "with all these things, time will tell, won't it?"