The inexorable march of electronification is quickening the tempo of nearly every aspect of financial services.
One corner of the industry is bucking that trend, though, as private equity firms launch longer-lived funds and extend their portfolio company holding periods — a trend facilitated by investors’ ability to buy and sell fund stakes in secondary markets with growing ease.
In recent years, private equity firms including Blackstone, Carlyle, and CVC have increasingly launched funds with lifespans ranging from 15 years to so-called perpetual vehicles, extending PE funds’ once-typical 10-year horizon.
Industry leader Blackstone now has 14% of its assets in perpetual vehicles — a sevenfold increase over the last five years. Long-term vehicles accounted for 90% of the firm’s LTM revenue.
Such funds reduce firms’ fundraising costs. They also let funds hold portfolio companies for longer, allowing them to implement more time-intensive turnaround strategies if needed or avoid selling in a down market.
Longer time horizons could stimulate greater use of alternative data in private equity. By giving funds a larger window in which to buy and sell companies, they encourage analysis of industry data to identify local, regional, and global cyclicality that could uncover bargains. Just 27% of PE firms now use alt data.
That analysis could be particularly useful in pointing the way in a vast private company data desert with few information oases.
In addition, recent research suggests funds could benefit from a more deliberate approach to buying companies, showing that firms deploying more capital in a fund’s first year tend to earn lower returns.
With new tech initiatives like AI, blockchain, and quantum computing sometimes taking years to pay dividends, longer time horizons also open up a broader range of R&D alternatives to portfolio companies.
For investors buying stock in PE firms, funds with longer time horizons appear attractive because they deliver more predictable long-term revenue in the form of fees rather than variable profits from sales of portfolio companies.
A company considering selling to a private equity fund, meanwhile, may be more willing to do so if it believes the fund is making a long-term commitment to enhancing its value.
Funds with longer time horizons may also attract family offices looking to place money for a long time. In the past, that dynamic has been a double-edged sword, with some investors reluctant to commit to an indefinite period of illiquidity.
But the emergence of an increasingly robust secondary market for private equity fund stakes has served to alleviate those concerns. Secondary asset digital marketplace Palico released preliminary estimates of 2018 volume last month indicating impressive 29% YoY growth.
Moreover, the strategy of selling fund stakes in the secondary market — once viewed as a “‘hunting ground for bottom fishers looking for distressed assets’” — has gained currency as a legitimate exit strategy. The mean transaction in the secondary market is now priced at 102.5% of its fund’s net asset value — a high since record-keeping began two years ago.
Even PE firms themselves have options for mitigating the risks associated with launching longer-term funds. Firms like Dyal Capital, Goldman Sachs’ Petershill unit, and Blackstone are increasingly buying minority stakes in other PE firms, allowing firms to diversify and share risk in a “fast-expanding field” that could aptly be dubbed meta-private equity.
To the extent that technology has connected private equity’s multitude of players in a vast — if invisible — web, it has boosted liquidity across the space. That dynamic has eroded barriers to longer fund time horizons. In that sense, electronification has ironically slowed the gears of private equity even as it speeds them elsewhere in financial markets.