Private equity’s latest trick is to buy and hold

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Warren Buffett famously said that when he owns outstanding businesses with outstanding management teams, his favourite holding period is “forever”. Fix-and-flip private equity bosses have come round to his way of thinking.

Evergreen funds, which do not need to return money to investors within the decade or so of the traditional closed-end fund, are taking off. Their number has doubled over the past five years and they now account for $350bn of net asset value, according to Preqin. That is still small beer, and largely focused on real estate, private credit or buyout strategies that piggyback on existing traditional funds. But the industry hopes it will grow into a standalone asset class. 

It is not hard to see why. The time constraints of closed-end funds are increasingly onerous. Raising a fund and then looking for companies to buy means that a lot of cash is sitting on the sidelines, damping overall returns. 

The past two years have highlighted the flipside of the equation. The private equity industry has $3tn of unsold assets — more than 40 per cent of which it has held for more than four years. Investors are clamouring for promised returns and distributions. But being a forced seller into a choppy market is no fun. Hence the growth of secondary deals and continuation funds that allow firms to sell assets to one other, and themselves. 

There is a more fundamental problem. Private equity strategies have evolved in a way that is ill-suited to the life cycle of the closed-end fund.

Buying banged up companies to restructure and sell was a good way to make a quick buck, especially when debt was cheap. Now there are not as many fixer-uppers to be had, and leverage is expensive. Roll-ups — buying a platform company and using it to consolidate an industry — are longer-term propositions. Average holding periods have risen; funds are often extended beyond their standard 10-year life.

Open-ended funds raise their own crop of issues. Investors will put money in — and take limited quantities out — at the net asset value at that time. Without periodic disposals to provide a reality check, the firms need to find a way to inspire confidence in how net asset value is calculated.

Investors should be asking what distinguishes private equity from other, more traditional, investment strategies. Taken to its extreme, the open-ended fund converges with, say, Berkshire Hathaway, arguably the world’s original evergreen vehicle, or even buying and holding the S&P 500 on margin.

Neither approach generates private equity-style returns, or charges private equity-style fees — two areas in which convergence is also likely to apply.

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