Private equity has a short-termism problem.
The typical fund life cycle — in which private equity firms raise money from investors, use it to invest in companies, manage those companies for three to five years, then sell the companies to return money to investors — prioritizes immediate profits, sometimes at the expense of long-term performance, critics say. Private equity funds may involve a long capital commitment, but the investment strategy is, at its core, about short-term change.
“The fund structure requires managers to sell,” explains Andrea Auerbach, managing director and head of global private investment research at Cambridge Associates. “You bought the company, and now you have to sell it.”
Increasingly, however, private equity managers and investors are looking to prolong the life cycle of their investments, Auerbach says. From long-dated vehicles, which function as an extended version of a regular private equity fund, to blank-check special-purpose acquisition companies, which raise funds through an IPO to invest in private equity-like transactions, so-called permanent capital funds are “definitely on the rise,” she says.
Some of the world’s largest private equity firms, including the Blackstone Group and the Carlyle Group, have launched these longer-term vehicles over the last few years. Carlyle announced in October of last year that it had raised $3.6 billion for its long-dated fund, Carlyle Global Partners. In a joint statement at the time, Eliot Merrill and Tyler Zachem, the fund’s co-heads, described an “innovative” mandate to “invest long term alongside owners and management teams.”
Yet the idea of a private equity fund investing for the long term isn’t new. Mason Myers, the founder of one such long-dated fund, Greybull Stewardship, traces the idea back to the 1970s and 1980s, when the Yale University endowment partnered with venture capital firm Sutter Hill Ventures to develop an evergreen fund structure.
The approach was apparently successful, as Yale has since adopted the permanent capital structure with other managers, including Golden Gate Capital, which was listed among the endowment’s private equity partners in a 2010 report. Golden Gate describes its approach on its website as an “infinite time frame for capital appreciation” that allows it to “build [a] company’s long-term value and generate superior returns for our investors.”
At Greybull Stewardship, a lower-middle-market-focused private-equity firm that caters to family offices and wealthy individuals, Myers says he runs one fund with a 40-year life cycle, or roughly four times that of the average private equity fund. The fund is then broken down into ten four-year cycles, giving limited partners regular opportunities to withdraw, renew, or change their commitments.
“There’s a better alignment between the general partner and the limited partners in an evergreen structure,” he says. “In other structures you’re forced to sell winners early so you can get good returns and raise the next fund. But when the time horizon is open-ended, you’re free to focus on the best way to maximize value.”
A longer-term approach is also more aligned with the management teams of portfolio companies, Myers adds, making it easier for GPs to source investments. As Cambridge Associates’ Auerbach puts it, truly evergreen vehicles are the “holy grail” for private equity managers. But very few exist, she adds, noting that few managers are able to execute the concept.
Even as more private equity firms attempt an evergreen structure, adding long-dated or permanent capital funds to their existing lineup of products, Auerbach says she has “deep suspicions” about whether these funds actually offer better alignment with investors. But, she adds, many are offering lower fees in exchange for holding capital longer, so they’re at least cheaper.
A private equity executive who spoke on condition of anonymity was even more skeptical.
“Other firms that have these fundraising complexes are now saying, ‘We have a credit fund, we have a distressed fund, we have this or that or the other thing, and we need perpetual funds too,’” he says. “It’s not born of the investment strategy; it’s a sales technique and opportunity for them to raise yet another pool of capital — which will compete with their core private equity fund.”
The evergreen structure can work, he adds, when it’s a single fund targeting what he calls “truly transformative change” at its portfolio companies. But this executive believes many firms are just using the longer lockup time to buy higher-priced companies, which ultimately produces a lower return.
“A lot of what’s out there is more gimmicky — ‘How else can we generate fee income over the long term?’” he says. “It’s focused on gains for the GP rather than gains for the LP.”
Still, Auerbach says the trend of private equity managers and investors moving to permanent capital structures will likely continue — if only because investors don’t have any better options.
“The reality is, in the current environment, if you give me money back, there’s not really anywhere else to put it,” Auerbach says. “So investors will let it ride.”