Faster isn’t better when it comes to private equity firms deploying capital.
eFront, an alternative investments technology firm, released research Wednesday that shows an inverse relationship between how quickly private equity fund managers deploy capital and how their funds perform.
According to eFront’s research, fund investors are under pressure to put their available cash on hand to work. It’s difficult for the investors to find yield in a low-rate environment, so they push private equity fund managers to call capital as soon as possible.
This won’t help their investments perform well, according to the report. “Under pressure, fund managers might have less freedom to select the best opportunities over time,” the report said. “Putting pressure on fund managers to deploy capital could thus lead them to execute investments they would have normally decided to pass on.”
What’s more is that the pressure to deploy capital doesn’t really translate into less cash on hand for investors, the report said. The use of subscription lines of credit, or loans most private equity managers use to decrease the frequency of capital calls, has changed the dynamic between investors and fund managers, the report said. “Fund investors might face the situation that the capital reserved for actual investments sitting on their account as capital calls are delayed by the use of credit lines,” the report said. “As this practice has gained momentum rather recently, it is difficult to assess the actual impact for investors.”
The report also analyzed the relationship between the total-value-paid-in multiple (a performance metric that shows the fund’s total value as a multiple of its cost) and the amount of capital deployed by a fund in its first year at leveraged buyout funds between 2000 and 2010.
When an LBO manager deployed more capital in the first year of the fund’s existence, its performance declined.
[II Deep Dive: Private Equity Capital Calls Fall to Record Low]
“This analysis debunks some common assumptions about drawdowns,” Tarek Chouman, chief executive officer of eFront, said in a statement. According to Chouman, investors should give their private equity fund managers the flexibility to deploy capital on their own timeline.
“Having the freedom to deploy or not is an important tool to invest for fund managers,” he said in the statement.