Private equity's tail risk
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Limited partners in private equity funds are usually reluctant to sell their positions at a loss, fearing reputational risk. The steeper the discount, the stronger the hesitation.
- They're making a mistake, argues Joncarlo Mark, who used to lead PE investments for CalPERS and served as chair of the Institutional Limited Partners Association.
Driving the news: Mark currently leads advisory firm Upwelling, which just released an insightful new white paper called "No Country for Old Funds."
- It examined 1,200 U.S. buyout funds over the past 20 years.
- The top finding is that fund performance peaks by Year 10, no matter the decile, and universally declines after Year 12. Rather than a J-curve, it's more like the number 5 resting on its hump (you can draw it, I'll wait).
- That means most LPs would be best served by selling these tail-end funds, even at major discounts, and redeploying the capital. Break glass, beat benchmark.
What they're saying: "This should be a call to action for LPs," Mark explains.
- "Particularly now when there is an active secondaries market and you consider one's ability to recycle into more effective funds, or coinvestments. Even U.S. Treasuries right now are offering better returns to what LPs often get after Year 10."
Zoom in: Upwelling also discovered early warning signs of underperforming funds, which it thinks can be identified by Year 5.
- The metric it uses is average annual change in TVPI, and argues that if a fund isn't within 11% of median TVPI by Year 5, it likely will remain in the fourth quartile forever.
VC angle: Upwelling looked at U.S. buyout funds because they provided the deepest data pool, but Mark says the venture funds likely have a bit longer growth curve but the end result is the same — peak and then an extended tail-off.
The bottom line: Private equity portfolios are aging, as exits have become harder to come by. LP portfolios needn't follow suit.
