The future of tail-end funds

Built-in liquidity solutions or asset rollovers will soon take care of ageing funds.

What will a typical private equity limited partner look like in 10 years’ time? Will closed-ended fund investments still play a prominent role in its portfolio, or will co-investments, direct investments and separately managed accounts take the lion’s share? Will it still be willing to pay management fees to GPs? Will it have finally broken down the transparency and disclosure barriers it has been chipping away at since the global financial crisis? Will ‘limited partner’ even be the correct way to describe it?

Tail-end funds

The LP of the future will have no unwanted funds that have outlived their 10-year life. Portfolios will be devoid of zombies. Assets will have been rolled into new structures or a pre-agreed liquidity process will have been triggered and LPs would have opted to cash out with the help of the buoyant secondaries market.

According to Goodwin fund formation partners Shawn D’Aguiar and Ajay Pathak, GP-led liquidity options are likely to feature regularly in fund documents, whether in the form of a promise by fund managers to hold a tender offer at a certain point in a fund’s lifespan or a less binding agreement that the GP will help an LP seek a secondaries buyer if it wants to exit. These innovations won’t mean the death of the tail-end secondaries market. Thanks to the sheer weight of primary fundraising the acquisition of funds near the end of their 10-year life is bound to be a much bigger market in 10 years’ time.

John Carter, founder and chief executive of Hollyport Capital, believes the market will be dominated by perhaps four specialist secondaries buyers. GPs are increasingly insisting buyers of stakes in their funds are managers with which they have an existing relationship.

Also contributing to a tidier portfolio will be innovation in longer life funds, taking a cue from the real assets world. The Goodwin lawyers point to a recent high-profile example – Core Equity Holdings’ 15-year, €1 billion debut fund last year – on which they advised.

Savvy use of the secondaries market will also allow a chief investment officer to increase or decrease certain investment exposures on a much more frequent basis, providing some liquidity in a long-term asset class.

“The transaction and friction costs right now are too high for that, it requires GP approvals and usually involves a process, but I would imagine over time, the secondaries market could become far more liquid and with less friction from a transaction perspective,” says TorreyCove’s David Fann.

“This approach works well if it’s highly liquid, where you can actually buy and sell secondaries in an exchange-like fashion. In a 10-20-year time frame, it’s not too difficult to see that possibly happening.”

LP of the future in 10 slides

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We are also likely to see more investment company-type structures, as GPs relieve themselves of the pressure of having to invest within the constraints of a fund.

For more of sister publication Private Equity International‘s LP of the Future special report, please visit here.