By that time, the average fund has hogenerated nearly all, or 96 percent, of its total gain, the study said. After year nine, the average fund produces just 4 percent of total value, said Nik Morandi, a Pantheon partner and co-author of “Residual Value in Mature Private Equity Funds.” (The other co-authors are Pierre Garnier, a Pantheon associate, and Ian Roberts, a senior research associate.)
“The value left after year nine was very limited for the average fund,” Morandi said.
Pantheon based the study on performance data for nearly 700 funds, including buyout and venture capital. It selected funds where there was at least 10 years of performance data available. The oldest pool was a 1983 vintage, while the youngest was from 2004. The study looked at performance, meaning IRR and total value to paid in (TVPI) capital of older funds, Morandi said.
The study found that first- or second-quartile funds still produced a better IRR than bottom-quartile funds during the later period (years seven to 14), Morandi said. “Quality still matters in the later years,” he said. “You are better off getting rid of third-quartile funds in later years even with the expected bump.”One surprise: Lower-quartile funds appeared to be “late developers.” These pools generated the majority of their value in their later years, from years seven to 14, Morandi said. “If you are a holder of third- or fourth-quartile PE funds, you need to be fairly patient because the value generated comes through much later than first- and second-quartile (funds),” he said.
Based on historical performance, the data suggest secondary buyers are better off buying first-quartile funds unless they can achieve a “very significant discount” on third-quartile funds, Morandi added.
So-called “zombie” funds – vehicles that generate very little or potentially negative returns – fall into the bottom quartile, he said. Based on the data, Morandi suggests that owners of these funds try to exit without suffering a big discount to net asset value or close to NAV.Mature funds delivered another surprise: Nearly one-fourth of the funds “fizzled out” after their sixth or seventh year and didn’t generate any value, Morandi said. Another 25 percent “went out with a bang” and generated more than half of total gains after year seven, he said. But for the average fund, most of the total gain is generated by year nine, he said.
Secondary buyers of mature funds need to be especially careful. “If they buy the right subset of funds at the right price they can generate really attractive returns,” Morandi said. “But if they buy wrong, they risk getting a potentially negative return.”
In today’s market, many LPs have chosen to trim down their private equity portfolios by selling so-called “tail-end” funds. These are investment vehicles in the last years of their lives (generally 10 years with a few one-year extensions built in) that still hold some investments and still require some investor monitoring.
Sales of these tail- end funds have helped boost the private equity secondaries market to record levels of deal volume over the past few years, with estimates for this year of more than $30 billion.
Returns on remaining NAV, by quartiles