Private equity, but not as we know it

Long-term funds will complement – not replace – the 10-year private equity vehicle.

In February David Rubenstein updated the market on The Carlyle Group’s progress raising its long-term vehicle, Carlyle Global Partners.

The fund is the latest high-profile private equity vehicle to break from the typical 10-year lifespan, offering investors a longer time horizon in exchange for lower risk, lower fees and lower returns. The firm has already raised $3 billion from large limited partners with additional capital likely coming this year, he said.

Carlyle’s fund is not the first to offer a longer time horizon. The Blackstone Group indicated recently that it is speaking to large LPs about a similar structure, while CVC Capital Partners has already started to deploy its $4.5 billion Strategic Opportunities Fund, which is expected to hold businesses for between eight and 12 years and target mid-teen returns.

The rationale for launching such funds is clear: investors want them. A pension fund may have an investment horizon of 20 years. For an endowment or sovereign wealth fund, it may be 100 years. A longer-life vehicle, therefore, makes clear sense.

For managers, a longer investment period allows them to pursue opportunities that would otherwise have to be passed over, such as large established companies that have minimal need for operational improvement.

While these longer-term funds may address some limitations LPs and GPs have experienced with private equity, they also bring a new set of challenges. There is a need to carefully manage the potential conflict of interest that may arise between different teams within a firm, with the long-term investment team competing with their buyout colleagues when looking at investment opportunities. There is also the challenge of attracting and keeping an investment team when carry is potentially lower and slower to come.

Judging by the progress that CVC, Carlyle et alia have had thus far, one has to conclude that these questions have been answered to investors’ satisfaction.

When considering the relative merits and challenges that these vehicles represent, it is worth viewing them not as ‘tweaked’ private equity funds, but as part a new asset class altogether (given that they should be investing in a different class of asset). In a market environment of soaring asset prices, firms have continued to shift focus away from financial engineering towards value creation through transformational change. A more passive investment model represents a dramatically different offering.

This raises an interesting question for investors: what type of organisation has the stability and longevity to manage these long-term assets: a listed asset manager or a private partnership?

For a certain type of institutional investor, these funds sit somewhere between a commitment to a 10-year fund and a portfolio of direct investments. With this in mind, many believe that the format has a long future, and although it is by no means meant to replace the traditional private equity model, it could nicely complement it.