Limited partnership agreements typically give the general partner two automatic one-year extensions. After the automatic extension periods are over, the GP then has to ask limited partners for extensions. Management fees are typically paid during the entire time, albeit sometimes at a lower rate than the fund's investment period."There is a cost burden to managing mature funds beyond a certain point," Mr. O'Connor said. "When a fund gets below a certain threshold of AUM, the fixed nature of certain administrative and management costs becomes a disproportionate slice of investors' return as the fund gets longer in the tooth."
And there are always going to be tail-end funds in the making. "We routinely see a reluctance by managers to deal with problem assets, that in and of itself is why certain funds get stuck, and particularly if a manger is underwater, hanging on to the hope that he can recover," Mr. O'Connor said.
The assets in tail-end funds can grow quickly following a recessionary period. Between 2007 and 2010, tail-end fund assets increased by 581% to $122 billion, the BRG study showed. Total global private equity AUM grew only 36% to $1.3 trillion during the same period. After the Great Recession, mature assets grew staler due to the illiquidity and uncertainty, the study said.
Even so, it is different this time, the study noted. The tail-end fund AUM is larger than it was in 2008, and the pandemic has already affected a far broader geographic and sector asset base, the study said.
Tail-end fund AUM will grow more in this recession because of the volume of capital already scheduled to mature post-COVID-19 due to the record levels of fundraising prior to the pandemic-induced recession, Mr. O'Connor said. Private equity funds worldwide raised more than $500 billion a year through 2019 when private equity raised $595 billion, according to Preqin.
"There are managers that have year eight or nine funds that are going to have to find exits, either in the public or private markets, but now most likely at lower valuations," he said. "Their dilemma is: Do they transact at a lower valuation level in the near-term markets or wait for a better day, which could be a couple of years out?"
Given the large increases in capital raised since 2013, it follows that there will be more tail-end funds over the next few years, Mr. O'Connor said. In fact, BRG executives are tracking some funds in their late cycle, in years eight and nine, beginning to exhibit tail-end fund characteristics, he added.
The effect of the COVID-19-led recession is also expected to slow tail-end fund distributions to investors, the BRG study said. In the last recession, tail-end fund distributions declined by 50% in 2008. Since 2016, tail-end funds have distributed about $200 billion each year, the study showed. Despite these record distributions, even more in value remained undistributed at the end of each year. For example, in 2018, $204 billion was distributed compared with $324 billion in unrealized value, the study showed.