Why LPs should think positively about fund restructurings

There is a cohort of crisis-era funds which investors would be better off getting out of or re-incentivising their GP.

In a mature fund that’s hovering around its hurdle rate? Maybe you should push for a fund restructuring.

That was the conclusion of some number-crunching by Hamilton Lane this week.

According to the investment manager, limited partners in crisis-era buyout funds that haven’t yet hit their hurdle rate should consider pushing for a secondaries process and selling out.

Why? Because having finally got over the hurdle, it is mathematically unlikely that these funds will make it through the GP catch-up periods. In other words, barring a miracle, any remaining distributions are likely to flow back to the GP.

Hamilton Lane, which invests in GP-led deals as part of its secondaries programmes, looked at 12-year-old funds that are at their preferred return on a net basis and where no GP catch-up (the point at which distributions from a portfolio are directed to the manager instead of the fund’s LPs for a period) has been paid. For this cohort, GPs with 5 percent of the original fund size’s NAV remaining must work almost three times harder to receive their full GP catch-up – and hence start paying out to LPs again — than those with 45 percent of NAV remaining.

So if you’re an LP in this group of funds with a small amount of NAV remaining that has reached the end of its life and has gone through two year-long extensions, there’s a high chance you won’t see a penny more in distributions. Mathematically, a fund with 5 percent of remaining NAV must deliver 3.3x to escape its GP catch-up period, whereas one with 45 percent in NAV remaining only needs to deliver 1.3x, according to Hamilton Lane.

“If you’re an investor you’re probably looking at a scenario where as more companies are sold, you’re not going to get those distributions because they are paid out in the catch-up profit share,” said Richard Hope, Hamilton Lane’s EMEA head of secondaries.

Enter the GP-led restructuring in which LPs rolling over into a new vehicle can benefit from reset economics and their manager being better incentivised – at least in theory – to maximise the value of the portfolio.

There are LPs out there which – for a number of reasons – do not look kindly on fund restructuring processes. At the same time, many investors, such as Australia’s Future Fund and Sweden’s AP7, are becoming enthusiastic about secondaries processes in general, as we’ve reported in recent weeks.

To be fair, Hamilton Lane is not suggesting that all mature funds should be restructured; simply that LPs should be thinking harder about this rather than waiting and seeing. If their data is anything to go by, certain LPs now have a compelling reason to develop formal strategies to help them decide whether they want to be a remainer or a seller.

LPs – do you agree? Let us know: adam.l@peimedia.com or @adamtuyenle