Recent studies suggest that it takes longer for private equity funds to return capital back to investors. This means that the so-called life expectancy of these funds is increasing. Should investors get used to waiting for their returns?
According to a Financial Times article, the median fund dissolved in 2014 had the lifespan of 13.2 years. This means it had increased almost two years, as the lifespan stood at 11.5 years in 2008. As private equity sector keeps growing with investor demand, finding deals is becoming increasingly competitive, which in turn can increase the lifespan even more.
Holding on for Longer
A typical fund used to invest all of its capital by year five, with most of the money being returned back to investors around the ten-year mark. But the situation is now changing rapidly and investors need to be prepared for this.
Much of this is due to private equity firms holding on to the companies they acquire for longer. The average holding period has increased by almost twofold. The current holding period is closer to six years, while three years was a much more typical scene prior to the financial crash.
Private equity funds are currently sitting on record numbers of equity. According to Preqin, there has been an 11.9% increase in dry powder on 2013. The total amount stood at around $1.2 trillion in December 2014.
What Can Investors Do?
If investors are nervous about waiting for their returns, there are some alternatives. The Financial Times analysts proposed selling “their stakes to specialist vehicles that buy up residual private equity funds”. Furthermore, Helen Steers, from the European primary investment platform Pantheon, said active management of the fund also helps. Selecting the right private equity funds as well as fund managers is crucial for fund success.
It seems some investors might already be focusing on vetting managers more carefully. Interestingly enough the Preqin 2015 Outlook report shows that investor appetite for new fund managers has died down a bit and investors are opting for more experienced managers. Furthermore, the report says investors are “becoming increasingly sophisticated and many are seeking alternative ways in which to access the asset class”.
Becoming the Norm
It is very unlikely that private equity fund lifespan will decrease in the near future. Although things may not go back to normal, it’s also unlikely the lifespan will continue to grow much longer. According to the Money China Network, the exit environment is currently very positive, and low interest rates and available credit have halted the fund life increasing further.
But as the Preqin report showed, investors have been receiving relatively good returns in a stronger exit environment. There is also great investor appetite for investing in private equity. This could mean that 2015 is another record-breaking year when it comes to fundraising. But this poses the risk of increasing competition for deals, making it hard for funds to deploy capital, which in turn will keep fund lifespans high. For investors, it is another change in the sector they must get used to.