In pursuit of our ongoing mission to bring more transparency and accessibility to private fund data for all investors, we analyzed the life cycles (or j-curves) of thousands of private market funds. Through our analysis we have come away with several insights that have important consequences for the growing universe of private fund investors.
To set the appropriate framework, it is worth reviewing the ‘conventional pitch’ of a fund life to investors. A traditional private fund typically has a 10-year term in its offering material. The Fund Manager (GP) typically has two yearlong extension options to liquidate remaining portfolio assets, which technically implies a combined 12-year term of a fund.
|Representative Fund J-curve|
Within this timeframe, there is an investment period of five to seven years, during which the fund manager purchases portfolio assets and works to enhance the fund’s performance. This is followed by a five- to seven-year harvest period. At this point, the fund manager positions the investment for liquidation to monetize a return for the fund’s investors.
That’s the pitch. Our analysis of thousands of j-curve data reveals a much different reality, insights that may impact how investors deploy their capital and their timing expectations. Large institutional investors may perform this level of analysis on their own or purchase it from large data companies. Smaller or less-resourced investors usually don’t have access to such j-curve analytics, so we decided to provide it here.
In practice, fund commitments can have timelines that go well beyond the 10 to 12 years initially indicated in the fund terms. Understanding and planning for this could be the difference between realizing significant returns within a reasonable time period or having capital tied up—and unavailable for potentially more lucrative opportunities—for longer than you might expect.
Here are our top three takeaways regarding private fund j-curves and what you need to know.
1. Private market funds take an average of c. 9 years to return invested capital.
Looking across the six core private fund strategies, we observed a wide range of j-curve outcomes. The big takeaway for investors is that the average time it takes to return invested capital (the breakeven) is c. 9 years. This suggests that the total life of the fund could be quite longer than 12 years to generate required investment returns on top of returning investors’ capital. The following charts highlight this for the respective six core private market strategies where we express the ‘mean fund’ per strategy as being the average of the net cash flows of the respective individual funds.
Some strategies like Venture Capital take up to an average of 11 years to break even, reflecting the increasing length for which these funds hold assets. On the other end, Private Debt typically returns capital to investors within 7 years because loans are often refinanced before their scheduled term, and in general, have a five- to seven-year maturity.
A solid understanding of a strategy’s expected j-curve enables investors to manage their cash flows and overall portfolio more efficiently. For instance, knowing the possible cash flow characteristics of an investment, you may choose to diversify your portfolio differently or invest in other shorter-term opportunities depending on your cash needs. In addition, continuously tracking a fund’s comparison to thousands of historic j-curves provides guidance on the fund’s trajectory, and the likelihood of its distributions. This information can help investors decide when to reposition portfolios through secondary sales or top-up purchases. Cash flow forecasting such as this is becoming a must have for large institutional investors.
2. The outperformance of top-quartile funds is significant.
While the importance of top-quartile performers is well understood in the market, looking at that relative performance through j-curves is quite telling. By breaking down j-curves into quartile performance (the quartile mean in the charts below), you can see by how much the top quartile funds outperform the rest of the group in terms of the speed of returning capital to investors and the ultimate performance of the investment over the initial 12 years of the fund’s life.
The graphs below split the j-curves into top quartile (Green), mean (Grey), and bottom quartile (Red). There is a large pull away of the top-quartile funds across all strategies when it comes to returning capital. As noted previously, this has real consequences for cash flow management, recycling, and the ability to re-up on existing relationships. For example, within Private Equity the top quartile funds break even at c. 6 years, while the mean breaks even at 8 years.
The analysis also reveals a greater range of outcomes even within the top quartile funds. That means that if you’re seeking superior performance (and who isn’t?), then just having a top-quartile fund in your portfolio may not tell the true upside or opportunity cost.
All of this suggests that investors need to visualize and quantify the actual alpha generated by a fund manager to its peer group. Being slightly on one side or the other of the 75th percentile may technically put a fund into the top or second quartile. But to make a more accurate assessment, you also want to see the dispersion of performance between your selected fund and others.
3. J-curves can be a leading indicator of performance or of problems ahead.
Through our inventory of thousands of j-curves, we have leveraged descriptive statistics and machine learning algorithms to produce various analytical models. In doing so, we extrapolated some meaningful trends that can help investors make even better decisions.
For example, by observing the development of a j-curve as a fund starts reporting performance, we can see how that performance is trending and forecast what investors may expect for the future. Such tools not only allow investors to generate a view of how a particular fund’s cash flow might develop, it also projects the net asset value of the fund and projects the possible run down of a portfolio. Combined, a user can then model an entire portfolio of fund investments and assess their netting effect to better understand the portfolio’s cash needs and projected risk exposure over several years.
As the charts highlight, there are real dollar consequences to not being within the top quartile—and an early understanding of performance allows you to be proactive. For most investors, private fund investing consists of just one decision over the course of a 12+ year commitment: “do I invest in this fund or not?”. We consider it critical for investors to be able to access relevant tools which provide a risk return assessment before making this long term investment decision.
Investors deserve access to private fund data
We built FundFilter to provide the necessary access to private fund data and analytics for every type of investor regardless of size, experience or budget. We consider it important that all such investors have access to data in order to have a better understanding of the risk return proposition of various strategies, how well or poorly a fund manager may have performed, what the cash flow implications of a fund commitment might look like as well as how to better assess future commitments within a portfolio.
FundFilter was built to help inform investors and level the playing field to the benefit of all participants in the market.
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