PE Key Trends Blog

Unexpected Offshoot of New Fund Structures: Longer-Term Investment

Sep 14, 2012, 5:47:40 PM

Tags: co-investment, diversification, holding company funds, Private Equity Market, strategies, V2

In the past three years, private equity strategies have become particularly creative, as LPs look to diversify away from blind pools overly dependent on leverage.

Much of LP diversification has focused on co-investment, the buying and selling of secondaries, deal-by-deal structures and strategies emphasizing yield and short duration, all of which give LPs greater control over investment decisions and offer relatively greater liquidity than investing in a classic leveraged buyout fund. But another emerging trend given a boost by the shortcomings of many credit bubble era funds seems to go in the opposite direction, tying up money for an exceptionally long period.

Referred to as “holding company funds” they aim to put LP money into investments that are not realized for decades, even though the standard life of a private equity fund is ten years. The role models for these funds are successful holding companies like General Electric, 3M, or the celebrated investment companies of German families. The GPs of these funds say that longer holding periods mean less correlation with public markets, and that less leverage is needed to goose potential returns. They also point out that promising companies wary of the classic private equity buy-and-sell-within-a-decade outlook are open to being bought by them, providing the funds with a key competitive edge. These holding company funds have no investment duration goals written into their LP agreements. Typically, they target an annual return of 20 percent, and will only sell a company when they think they can no longer get this.

One of the more intriguing innovations of these new funds is that they also offer the shorter-term flexibility that LPs have demanded from other alternatives to classic buyout funds. All of these funds have mechanisms that permit LPs to sell their stakes to GPs at small discounts of 2 percent to 5 percent. Holding Company funds are one more sign that private equity is getting both more diverse and more complex.