Invest1 publisher3 min readPublished
Three extra years of hold need 22.5% more exit value to leave private equity's investors level
Sebastien Canderle says buyout managers still cannot sell, so capital pension funds had budgeted to arrive after four or five years sits at carrying value while CalPERS's estimated 7% a year keeps compounding against it.
The Investor · Invest desk
What happened
- Sebastien Canderle writes at Naked Capitalism that buyout managers have struggled for years to sell portfolio assets since post-Ukraine rate rises slumped enterprise values, and that for some the dry spell is existential.
- Yves Smith's introduction says managers are keeping investor money beyond the customary four-to-five-year average hold, since cash only returns when a company is sold or value is stripped out in a dividend recap.
- Pension funds that had written those returns into cash planning based on actuarial projections, and spent them on obligations, are scrambling to fill the resulting shortfall.
- Naked Capitalism cites a CalPERS estimate putting private equity's extractive fee and cost levels at 7% a year, a charge that runs for as long as the asset is held.
Compiled by The InvestorSomething wrong?How this is made
Why it matters
- cost At the rate CalPERS estimated, a three-year extension needs about 22.5% more exit value before the investor is level, and the manager collects the fee whether that value arrives or not.
- constraint The gap lands on the investor's other assets rather than on the fund: money carried at a mark cannot pay pensions in payment, and nothing in the structure converts a valuation into cash.
- precedent Because the partnership agreements permit the wait, there is no remedy inside this vintage, and pressure moves to the terms of the next fundraise.
- contradiction Smith has limited partners welcoming understated markdowns in bear markets, which turns today's cash complaint into a complaint about a valuation practice those same investors preferred.
A delayed distribution still pays someone. Nearly two thirds of buyout fund income comes from fees collected regardless of performance [7], so a manager who cannot sell at carrying value is choosing between crystallising a markdown and continuing to bill, and under the limited partnership agreements the second choice is allowed [5], simply expensive. Take the CalPERS estimate that all-in fees and costs run about 7% a year [6] and the patience becomes arithmetic: three extra years at 7% compounding needs roughly 22.5% more gross exit value to leave the investor where a sale on schedule would have [1], and across a whole four-to-five-year hold [3] the same rate compounds to about 40% [2].
The other side of that ledger is a pension fund that wrote the old timetable into its cash planning, using returned capital to meet obligations its actuaries had projected, and is now finding the money somewhere else [4]. That capital, while it sits at a mark, pays no benefits in payment and is not being recycled into whatever the investor would choose today. Consider also that the smoothing now hurting LPs is the smoothing they wanted, since Yves Smith's introduction argues they treated understated markdowns as a feature rather than a bug because it let them report that things were better than they were in bear markets [8]. (She also describes resort-venue briefings, meals and entertainment charged to the fund rather than to the manager as bribes to the staff who select and oversee funds [12].)
The counter-thesis, or rather the more interesting version of it, is that this is a price problem, not a value problem. Canderle dates the dry spell to the aftermath of the war in Ukraine, when rising rates slumped enterprise values and opened a disconnect between private and public valuations [2], and if that gap closes from the public side then waiting was correct and the fees were the cost of not panicking. Windows do reopen fast: 480 US IPOs in 2020 was already an all-time high, and 2021 printed 1,034 [9], about 2.2 times the prior year [3] and 2.6 times the 397 of 2000 [4]. What 2021 also demonstrates is what an open window does to assets carried at sponsor prices, since many of those listings were pummeled in the aftermarket, with Blackstone's Oatly and Advent's Olaplex both down more than 90% five years on [10], and by mid-2022 the average SPAC of the 2020 vintage had lost 55% of its value while the 2021 cohort had erased two thirds [11].
This material carries no measurement. There is no aggregate figure for how far past four or five years the average hold now runs, no distribution rate, no spread between marks and clearing prices, and one consultant's account of an existential drought [2] is a single anecdote, not a census. The related warning that private equity is levered equity, highly correlated with public markets once the timing of its valuations is corrected [13], cuts the same way: if the correlation is real, the marks will meet the public prices eventually, in one direction or the other. So the 22.5% is the price of three years of patience at the rate CalPERS estimated [1], and the term with any give in it is the fee, because the sale date belongs to the manager [5].
What to watch
- Exits from buyout portfolios pricing at or above carrying value, the only direct test of whether the marks are real.
- Fund extensions negotiated with reduced fees, which would price the delay instead of leaving the investor paying for it.
- Any pension fund disclosure of how it funded obligations that private equity distributions did not cover.