Private equity funds typically have a 10-year life, with the option for several one-year extensions. In a new development, GPs have started introducing what are known as long-dated private equity funds, with terms of 15 years or more (some even have no fixed term).

In my recent white paper, “Long-Dated Private Equity Funds: More Illiquidity Please?” I described the key features of these funds, with a focus on what institutional investors need to consider in evaluating long-dated strategies.

In this blog post I provide a top-level overview of these funds and their potential benefits and drawbacks.

Potential Benefits

• The businesses targeted by long-dated funds tend to be healthy, mature companies with stable cash flows. While they will not generate the outsized performance associated with traditional private equity investments, these companies may have stronger downside protection. Returns for these funds stem predominantly from the compounding of capital over time, with periodic cash dividends to investors.
• Long-dated funds can give investors access to a unique opportunity set of companies that do not, for one reason or another, fit the parameters of those typically found in traditional private equity funds.
• Private equity GP-to-GP transactions are becoming more common, and for more diversified private equity programs, companies can bounce around among sponsors within an investor’s portfolio. Long-dated funds can avoid the additional costs associated with GP-to-GP transactions due to their longer-term fund structure.
• To help offset the impact of lower IRRs, long-dated fund sponsors typically offer lower fees than traditional private equity funds. Investors should note that these erstwhile lower fees are paid over a longer time period, so the dollar amount over the life of the fund may end up being the same or higher than a traditional private equity fund.

Potential Drawbacks

• The biggest drawback of long-dated funds is their lower IRR return profile compared to traditional private equity. Target net IRRs are typically in the low to mid-teens, yet these are counterbalanced by the potentially lower risk of realized losses.
• Long-dated funds can be seen as a byproduct of product proliferation within the private equity industry. They are another way for GPs to earn fees. Investors must assess whether the strategy is consistent with the GP’s core competency, especially in terms of value creation, and understand the GP’s motives for launching the strategy (i.e., is it an “asset gathering” effort?).
• Long-dated strategies may face conflicts with respect to deal allocations among funds managed by the same GP. Many GPs with long-dated funds also have a flagship fund with a higher return threshold and, typically, priority in deal selection.
• Since GPs of long-dated funds will hold on to companies for extended periods and have more flexibility on exit timing, some may feel a lack of urgency to realize value. This could potentially drag down returns and promote complacency on the part of the GP.
• GPs often have to pay up for stable, fundamentally good businesses. While the ability to implement long-term operational improvements and growth initiatives may justify this higher purchase price, and the GP has more time to create value, it has further to go in growing the business to ensure a profitable exit.
• The longer-term structure creates issues around incentivizing investment professionals, due to the delay in the realization of carried interest, as well as succession planning for professionals nearing retirement.
• Because of the longer life of these funds, portfolio companies may face higher risks from regulatory policy changes or from disruptive new technologies.

Implications for investors

Long-dated funds do not make sense for many investors, especially those that use private equity primarily for return enhancement and expect a high level of distributions within a five- to ten-year investment horizon.

However, if an investor is looking for a potentially lower-risk strategy to match its longer-term investment horizon, a long-dated private equity fund is worth considering. The compounding of capital over time should ensure the investor receives a strong TVPI, even if the IRR lags traditional private equity. These funds may be particularly attractive for investors with infinite investment horizons, like sovereign wealth funds. Long-dated funds enable investors to invest large amounts of capital over a longer period of time, potentially reducing reinvestment risk within their portfolios.

A long-dated fund may also make sense for investors with larger private equity portfolios looking for diversifying exposure, where long-dated funds can complement traditional private equity exposure.