Among the many issues limited partners deal with, managing out legacy funds – some of which will never make any money – can be one of the most frustrating.
To some extent it’s an inevitable consequence of having a mature private equity programme. But occasionally, lurking within this legacy portfolio will be a “zombie fund” – an under-performing investment vehicle run by a management team that is unlikely to attract any future capital but continues to collect management fees.
A stark view into the world of zombies is provided by the California Public Employees’ Retirement System’s Vista Portfolio, which houses a collection of legacy funds that the giant US pension hasn’t been able to sell on the secondary market.
Vista includes some big winners: Alta V Limited Partnership, a 1992 vintage run by a venture firm called Burr Egan Deleage & Company (which dissolved in 1996), returned $84.5 million to CalPERS on a $35 million commitment. Another top performer was the fourth fund from Golder Thoma Cressey & Rauner, a 1994 vintage that returned $52.9 million on a $25 million commitment.
However, the portfolio also contains some investment vehicles that, in hindsight, appear to have been landmines.
One of them was the fifth fund from once-vaunted Argentinian firm Exxel Capital, a vehicle that was fully exposed to the Argentine economy when the country defaulted in 2001. Fund V, a 1998 vintage, was marked at a .10x multiple and a negative 38.6 percent internal rate of return, according to CalPERS fund data as of 30 June 2011. The pension system committed $75 million to the fund (a testament of the confidence the pension once had in the firm) and has so far received $4.7 million back.
The fund with the worst marks in the portfolio is American River Ventures, a US government-backed venture fund. This $100 million 2001 vintage vehicle was a complete write-off as of 30 June 2011, according to CalPERS data.
American River Ventures’ debut fund was formed with the backing of the US Small Business Administration’s Small Business Investment Company programme. The government acts as a preferred limited partner in the funds and is the first in line to receive distributions.
However, the government is also able to put an SBIC fund into receivership immediately if the fund “gets into trouble”, a person with knowledge of the programme says. “[The government is] cranky, really cranky. They don’t like these funds to go into receivership, but they can negotiate to take x cents on the dollar to get out,” the source said.
In American River’s case, the relationship just didn’t work out. The government got tired of waiting for returns and forced the firm to sell to a secondary buyer, according to John Kunhart, managing director and co-founder of American River Ventures.
“The government wanted their money back in the middle of a recession,” Kunhart told Private Equity International recently. “The programme is flawed in the fact that it predetermines when you have to pay the [government] money back. Get your crystal ball and tell me what the market is going to do.”
A spokesperson for US Small Business Administration was unable to provide information about American River and the decision-making around the fund.
However, despite the tough marks from CalPERS, the fund is in a better position than ever, according to Kunhart, and is expected to return some percentage of capital back to investors in the fund. The fund also has some dry powder left for add-ons to existing investments, he said. “We stand a good chance of getting a good percentage of our investor money back,” he said, although “it’s impossible to say what percentage”.