Private equity investors are increasingly inclined to put some of their funds in long-term investment vehicles — and they achieve better returns for the longer commitment, according to a new report.
The report, “Global Private Equity Report 2018,” reveals that longer holding periods in private equity present an opportunity for superior returns on committed capital in the long run. It was published by private equity pioneer Bain & Co.
The typical approach of PE firms is to sell out of companies they acquire within a three-to-five year holding period. But that approach has limitations. For one, it creates recurring costs for the fund and the limited partners that invest in them.
Cost is making PE firms to look for long-hold investments.
The Bain & Co. analysis points out to various large PE firms, including The Carlyle Group, CVC Capital Partners and Blackstone, who have been coming out with buyout funds with a longer lifespan.
Blackstone raised $5 billion for a fund with an estimated holding period roughly double that of the traditional buyout funds.
First-time funds Cove Hill and Core Equity have also raised $1 billion each with an expected holding period of up to 15 years.
The market is currently seeing two major types of long-hold funds.
The first are “core” buyout funds that focus on portfolio companies that present lower risk with lower return. For instance, CVC Strategic Opportunities Fund has a life span of 15 years, and targets an internal rate of return of about 12% to 14% while charging lower fees to investors.
The second major type is a long-hold buyout fund.
They focus on the risk-return profile as well as the fees (similar to traditional buyout funds). In this type of a fund, investors do not need to sacrifice a part of the returns in exchange for the longer duration.
The advantages of both types of funds, according to Bain and Co.:
- Transaction costs, such as consultant fees and taxes, are lower
- The portfolio company management has fewer distractions
- Capital gets fully invested for a longer period, reducing the waiting periods for reinvestment
- Deferred capital gains taxation, enabling capital to compound over time
- Greater flexibility in terms of the investment horizon, enabling the fund to sell out at an optimal time
- Access to businesses looking for patient capital for long-term growth
Strategy for investors
The Bain report says that longer holding periods are likely to endure for the medium term at least.
But investors should have a clear understanding of the duration risks that exist in most industries. Regulations, competitive threats, and technology can change rapidly.
Investors should perform re-diligence of their portfolio companies every few years in order to update their understanding of the current industry dynamics and the asset’s competitive positioning.
If the duration risks become too high, it may be time to sell out. If ‘hold’ seems to be a better answer, then adjust the plans in order to keep creating value, Bain advised.