No Merry Christmas for Private Equity Limited Partners
Published: 12/25/2024
Read Time: 3 min
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“Oh! But he was a tight-fisted hand at the grindstone, Scrooge! a squeezing, wrenching, grasping, scraping, clutching, covetous, old sinner!”
-- A Christmas Carol
This article represents a Bah Humbug and big lump of coal to Limited Partners as exits continued to be 50% below target in 2024.
Overvalued assets, which continue to gather fees as Scrooge’s old wool coat gathered dust, bleed LPs of distributions, while LPs are offered the crumbs of Continuation Funds or piled on debt to fund distributions. These financial engineering sleights of hand have partly replaced value added exits as the primary means of returning cash to investors.
The assets in Private Equity funds are carried at inflated values thereby inflating both the fees the Private Equity sponsor earns as well as the IRR performance metric using the inflated value. Even Goldman (GSAM) estimates assets are overmarked by 10-15%. This is not surprising, as I’ve previously written that LP secondary sale discounts imply overvaluation on the order of 20%. This is an open secret that only the valuation auditors seemingly aren’t privy to.
The article cites Cambridge as predicting the asset overhang will take years to work out and cites Bain as reporting the overhang at $3T.
The use of Continuation Funds continued to explode in 2024. I’ve written about Continuation Funds in several prior posts but if you’re not familiar, let me introduce you to the concept with an ad that should be used to market these funds:
“We’re pleased and excited to offer you the opportunity to invest in a new fund backed by the dogs, err investments, we couldn’t sell in the last fund and that definitely ARE NOT overvalued.”
Generally missing from the narrative and not mentioned in the FT article is that this predicament can be directly traced to the flawed methodology ratings agencies used for CLOs. This clearly allowed aggressive debt leverage on obviously unsustainably low interest funding cost. As CLOs buy the lion’s share of Private Equity debt, rating agencies directly contributed to loan funding structures that would not have occurred absent this critical rating approach flaw.
Link to article below: