Ahead of the Curve: Is Permanent Capital on the Rise?
While Berkshire Hathaway has invested permanent capital for decades, several large PE firms, including CVC, Carlyle and Blackstone, have been launching buyout funds with longer lives. Blackstone raised $5BN for a fund with expected holding periods roughly double those of the traditional buyout fund. Two first-time funds, Core Equity and Cove Hill, also raised more than $1BN each for funds with anticipated holding periods of up to 15 years. (1) Family offices, who have historically taken long-term hold positions in investments, saw a 300% increase in capital committed from 2011 to 2016 according to Pitchbook. (2)
Permanent capital is capital that can be invested in perpetuity – usually without a target date when capital must be harvested and returned to investors. (2) It has traditionally been raised through a variety of vehicles including family offices, publicly listed companies, special purpose acquisition companies and insurance company capital reserves and premiums. Compared to shorter-term (e.g. 3-5 years) holding periods Permanent capital has some advantages. The most notable are listed below:
1. Lower frictional costs: Transactions are fee generating events (e.g. taxes, advisory fees, etc.). Costs related to a one-time transaction at the end of a long-term hold will likely be less than those associated with the frequent buying and selling of businesses. The benefit of having capital fully invested over longer periods with less time waiting to be reinvested also contributes to improved returns. The 2018 Bain & Co. Global Private Equity Report illustrated that a theoretical sale of investment after 24 years outperforms a short duration fund completing four successive transactions by almost 2X on an after-tax basis, assuming performance is equal. (1)
2. Potential to realize growth objectives and optimize exit timing: Flexibility on the investment horizon allows management more time to execute on longer term strategies that can bring the full potential of the business to reality, as opposed to focusing on positioning the company for sale in three years. Furthermore, owners can elect to ride out adverse market cycles if there are no time constraints for liquidity.
3. Access to companies looking for patient capital: Sponsors of the longer-lived funds cite the appeal of the long-term nature of the capital to family-owned businesses, that may otherwise be reluctant to sell to private equity. Last year, CVC invested in family-owned Asplundh Tree Expert LLC out of its long-term fund. The family partnered with CVC in part because CVC would be sticking around for longer, according to people familiar with the deal. (3)
It is still likely too soon to tell if the new longer-lived PE funds will have staying power as the funds are in early stages and it will be an extended period before results can be analyzed. While the 2018 Bain study estimated higher returns for a longer held investment, there could be other variables that have a negative impact, specifically purchase price. Long-term vehicles tend to buy stable, healthy businesses with steady cash flows (i.e. they cost more). However, to quote the most famous of long-term investors, “When we own portions of outstanding businesses with outstanding management, our favorite holding period is forever” – Warren Buffet, 1989 Letter to Shareholders. (4)
(1) Bain & Company, Inc. Global Private Equity Report 2018