A Wave of Zombies Is Rising From Private Equity's Slow Carnage
This article from Bloomberg may be of interest to subscribers. Here is a section:
Sticky bets can create dilemmas. Pensions and endowments can’t force private equity managers to sell. They can’t pull money from a fund without typically paying a price. Nor can they replace a manager unless there's evidence of wrongdoing. That means zombie funds can go on for years, sucking up pension managers' time and eroding returns.
Reports from 10 major public retirement systems show that they have a median 4% of their private equity portfolios locked up in funds older than 2009. Collectively, that’s $6.8 billion across more than 900 fund investments, some of which date back to the 1990s. Several funds were so troubled that they were delivering losses.
“Fund lives are going much, much longer,” Miller said. And with asset sales now more difficult, many managers face the same questions: “What, when and how are they going to exit?”
That’s an inconvenient counterpoint to private equity’s pitch that it can reliably take cash from teachers, police, firefighters and other civil servants and hand it back with significant returns a decade later.
When valuations are high and global liquidity is tight, the big question is where does the epicentre of risk reside? Following the global financial crisis, many investors swore they would never again invest in illiquid structures. However, very low interest rates persisted and liquidity remained abundant, which suppressed yields. Those same investors were lured back into the private assets market because they had to capture yield.
The consensus is now that a recession will be avoided even if growth slows down. I don’t think that is the most likely scenario; far from it. The number of zombie funds today is not an issue. The number in future could well be problematic because investments can be tied up indefinitely. Many pension funds have significantly increased allocations to private equity over the last decade. Not all will have the bandwidth to increase their weighting when prices are attractive.
The greatest skill in the financial markets is reaching the bottom of the deleveraging process with liquid funds intact, to take advantage of bargains, then having the courage to follow through and buy.
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