Pierre Garnier plies the data to find out if and when an investor should seek to sell a private equity fund interest, and reveals that a surprising number of funds seem simply to run out of steam

Pierre Garnier

Given the ever-increasing depth and breadth of the secondary market, private equity investors are now better equipped to manage the lifecycle of their private equity fund investments. This raises the question of whether there is a break point after which it may not be rational to hold on to a portfolio of funds. 

Pantheon has conducted a historical analysis on nearly 700 private equity funds of all stages (with vintage year ranging from 1983 to 2004), whose results we believe are one of the factors to be considered when deciding whether to sell or hold on to certain subsets of a portfolio.   

Our analysis shows the median fund, represented by the blue line in figure 1, had already generated 96% of its total ultimate gain by year nine, when measured by total value paid in (TVPI). 

Of greater interest perhaps is the level of dispersion within the overall dataset. By year nine (Q36), 25% of funds in the survey had yet to generate almost 30% of total proceeds, as shown by the light grey line. Conversely, another subset also constituting 25% of funds was exhibiting a higher TVPI between years six and 12 (Q24 to Q48) compared to final performance at maturity (as shown by the dark grey line), implying an investor was actually losing value in these funds from approximately year six onwards. Put simply, while 25% of funds in our dataset fizzle out by year six (Q24), another 25% go out with a bang much later. 

TVPI progression over time

Returns on remaining NAV quartiles

This poses an interesting question for investors looking to crystallise their returns and suggests that, historically speaking, holding on to an ‘average’ portfolio beyond year nine might not necessarily be optimal. Freeing up and recommitting that capital elsewhere may have enabled the holder of this portfolio to generate stronger returns or, at a minimum, provided the opportunity to access greater upside.    

While this can provide some understanding of when key inflexion points might occur during the course of a portfolio’s life, it does not by itself answer the key question: ‘Should an investor sell – and if so, when?’ 

The trade-off between holding on for more value growth versus monetising residual value should be governed by three variables: 

• What are the returns I believe my portfolio’s residual value is likely to generate, going forward?
• What pricing do I believe I could achieve if I were to sell my portfolio now via the secondary market? 
• What are the returns I am targeting for my private equity programme overall? 

Our analysis shows that by holding the funds from year eight onwards, an investor would only have generated a median IRR marginally in excess of 5%, at best. There would have been a clear rationale to consider a sale, if this future performance would have been dilutive to the overall performance of the investor’s private equity portfolio. 

The dispersion in returns is again significant, clearly showing there is no substitute for detailed knowledge of a portfolio in order to ensure any decision to sell fully considers remaining upside potential. 

One interesting finding that may help investors differentiate the funds to sell from those to keep is that, assuming par pricing, top-quartile funds (represented by the blue line in figure 2) delivered greater tail-end performance for the buyer than the rest of the sample set, and significantly outperformed third-quartile funds (represented by the light grey line) from year seven (Q28) onwards. In other words, quality continues to drive returns, even at an advanced stage of a portfolio’s life. Moreover, accepting a discount rather than par pricing should not necessarily deter sellers: the older the funds, the higher the probability the residual value represents a small proportion of the portfolio’s overall size, and therefore the lower the probability this discount has a significant impact on overall returns.  

In Pantheon’s view, however, the foregone IRR should be the more relevant consideration for most investors, rather than the proportion of total gain foregone. When allocating capital, the former can be compared to other available investment opportunities. The lower the expected returns available elsewhere, the lower the opportunity cost of holding mature private equity portfolios until maturity. The investor’s ability to assess a private equity portfolio’s value creation potential, at frequent points in time, and to benchmark this against other opportunities, should be a key component of any investor’s toolkit. 

Pierre Garnier is an associate at Pantheon and author of ‘Residual Value in Mature Private Equity Funds’

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