Zombie private equity funds represent investment funds where money is tied up for years, with the manager having little to no profitable investment prospects, yet managers are still imposing fees on the tied up money.
According to the Wall Street Journal, of the 10,000 or so private equity funds founded in the past decade, about 200 gave back far less than their original investor allocations (see here for the WSJ’s Illinois State Board of Investment example).
With an estimated $100 billion (at least) zombie money at stake, are zombie funds a problem?
The simple answer, not surprisingly, is: it depends. It depends on actual future return prospects, on future fundraising activities, and, of course, on perspective.
From the perspective of the private equity manager of a zombie fund, there is usually little to no incentive to close zombie funds, with a 1 to 2 percent management fee continually generating income to the “inactive” managers (2 percent of $100 billion is $2 billion, or $10 million per zombie fund by one estimate). The zombie manager may also be not so down-and-out on future prospects or fundraising activities than disillusioned investors.
Of course, on the other end, many investors with assets parked in what appear to be zombie funds may see the 1 or 2 percent management fees as wasteful, representing merely a further reduction in the expected returns.
What are some potentially mutually beneficial solutions to the issue?
The Economist magazine suggests a few.
The first is for investors to “reset the economics” of the fund. Essentially, this means accepting the poor initial performance of the fund, and providing further incentive for fund managers to achieve reasonable (or better than reasonable) performance in the future. The incentive may take the form of reducing the management fee and offering the private equity professionals 5 or 10 percent of the future profits.
The second is for new outside investors to infuse new cash into the latent private equity funds by taking over the companies of the zombie fund. This provides an out for worn-out investors.
A third option entails investors persuading the zombie fund manger to close its doors, valuing its assets, and distributing the cash value of the assets.
A fourth option is for zombie fund investors to unload their investment by selling their stakes. This option, though, comes with the disadvantage of selling at a discount, something individuals responsible for allocating funds to investment professionals are loathe to do.
With this background, are zombie private equity funds really a problem? After all, isn’t failure an important part of a well-functioning, free economic system? The Economist magazine, NewGlobe Capital, Coller Capital, and others appear to think so. Although for entities such as NewGlobe Capital, whose entire business model stems from the existence of zombie private equity funds, more zombies wouldn’t be bad for business.
Excluding entities who probably don’t think zombies are an economic problem, but rather a business opportunity issue, it’s still somewhat perplexing that the Economist magazine or certain authors at the Wall Street Journal would consider zombies a problem.
Maybe the consumerist point of view really is overtaking the world, ignoring the initial elements of risk and other factors.
In all, zombie private equity funds perhaps account for about $100 billion of investor money. Some see the issue as a business opportunity, whereas others see it as a problem in the entire deal structure.
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