Long-term vision: pros and cons of long-lifespan funds

Oscar Geen
09 July 2019

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Longer-lifespan funds have emerged as a popular т but not free from controversy т way of dealing with more hands-on value-creating strategies and LP appetite for diversified risk/return profiles. A panel chaired by Unquote's Oscar Geen delved into the issue at Unquote's recent Allocate conference

As private equity has matured as an asset class, it has evolved to appeal to a wider range of people and institutions. This includes attracting a broader range of investors, as well as making private capital available to a larger universe of companies.

One strategy that has emerged as a result of this trend is funds with extended lifespans of between 15-20 years. Well-known, multi-product GPs including Apollo, CVC, Blackstone and Goldman Sachs have launched products that fit this description in recent years, but the industry has also seen the emergence of GPs that are set up to operate purely in this segment such as Core Equity, Castik Capital and Cove Hill Partners.

Clearly there are some benefits to this type of strategy, and Aberdeen Standard Investments' Merrick McKay gave voice to its proponents at Allocate: "The standard PE model is a bit of a blunt instrument and regular funds have been used in the past to acquire businesses that might need more time to develop or have more modest growth aspirations," McKay said on a panel at the event, adding: "A lot of investors are now comfortable with a lower risk/return profile (in the mid-teens), so it makes sense for GPs to be heading in that direction."

However, the Polish Development Fund's head of private equity Annemarie Dalka had some concerns. Dalka highlighted the fact that many companies are already held well beyond the normal life of the fund and asked how long we should expect a 15- or 20-year fund to last in reality. "My concerns would be around lower returns and higher illiquidity," said Dalka.

Aberdeen's McKay had an answer for this concern. He argued that planning a longer duration for a vehicle at the outset is different to extending or restructuring towards the end of its life: "If longer holds are not part of the model from the start, it is actually an admission of failure in a way. It can be a good failure because there can be upside, but you are still not doing what you were supposed to do in the first place."

The standard PE model is a bit of a blunt instrument and regular funds have been used in the past to acquire businesses that might need more time to develop or have more modest growth aspirations" – Merrick McKay, Aberdeen Standard Investments

DWS Private Equity's head of business development Anamica Broetz explained how DWS is focused on these good failures: "We want managers to be able to hold onto assets and create more value. Approximately 40% of exits are SBOs, and that's driven in large part by the constraints of the 10-year model." DWS makes direct investments into portfolios and individual companies after the end of a fund's investment period, thereby allowing GPs to hold portfolio companies longer within the standard 10-year fund model. In some cases it solves a similar problem to the GP-led fund restructuring transactions that have taken off in Europe over the past three years.

Travers Smith's head of investment funds, Sam Kay, weighed in from a legal perspective: "GP-led restructurings are currently popular because they solve a problem – but arguably that could have been structured out to begin with, with a longer lifespan." This logic could also apply to the approach taken by DWS.

Stopping zombies
The motivations of GPs raising these vehicles was also questioned. If long-term funds have similar incentivisation structures to standard PE funds, it would seem that the risk of creating so-called "zombies", where GPs continue holding underperforming assets in order to harvest management fees, is increased. This was alluded to on the panel by both PFR's Dalka and Esas Holding's Ipek Mutlu, who asked: "Do they have ulterior motives, for instance taking advantage of a strong fundraising environment?"

Travers Smith's Kay has worked on a number of these funds and in his experience this has not been the case: "People may challenge some of the terms and numbers, but by and large everyone is pretty happy with the incentivisation model of traditional PE funds. How does that change with longer investment periods? That is definitely a challenge to the traditional structure. You could actually get some ideas from infra funds – perhaps pay carry based on the yield as you go, or something linked to increases in NAV. Deal-by-deal carry is still controversial, but perhaps that could also be a way of dealing with that challenge."

In general, the panel saw the benefits of long-term funds for a certain type of LP, but remained sceptical of some of the current offerings on a relative-value basis, particularly from large multi-product GPs. It is clear that there is a place for a range of different structures within private equity that appeal to a range of different investors and target companies of all typologies. However, many of the products currently in the market seem to make too few concessions to LPs when their lower target return and liquidity are factored in.

The second edition of Unquote's Allocate AGM was held on 19-21 June at the Grove in Hertfordshire