Navigating the Complexities of Tail-End Funds
There is no strict definition of a tail-end fund, but it is generally considered to be a private investment fund, usually with illiquid underlying assets, that is approaching or surpassing the later part of its planned term (e.g. 10 years for private equity, term varies by asset class). Some of the problems associated with tail-end funds include:
- Limited liquidity: Private funds are generally an illiquid asset class, the limited partner (LP) subscribes to the fund for the fund’s full term. If a tail-end fund holds mostly illiquid underlying assets there may be limited to no distributions and thus LPs do not have liquidity. LPs seeking earlier liquidity often rely on secondary sales of their interests (e.g. selling their LP position to a third party), however these sales can be at discounts to net asset value (NAV) and reduced the realised value achieved by LPs.
- Reduced visibility: One of the major challenges of tail-end funds is lower visibility on exit timing and valuation. The investment period is over and the fund has already gone through a harvest period – the remaining assets are often hard to sell/ value. NAVs can be stale or smoothed, so headline fund metrics may understate the uncertainty around ultimate realisations.
- Increased risk: The risks change as the fund moves through its life cycle. At the tail-end liquidity, concentration and duration risks are the major considerations. The “easier” assets tend to be realised earlier, the remaining assets tend to be harder to exit. However, sometimes the tail-end assets are high quality (hence the risk of continuation funds), so outcomes are very factor specific.
- Reduced manager attention: During and after the investment period, the general partner (GP) is focused on harvesting the fund and is incentivised to meet the carry threshold. Alignment concerns can arise, however, where DPI is low and carry is unlikely, and the economics of the tail-end fund might no longer justify active GP involvement. The reduced manager attention could potentially lower returns for investors.
- Relative cost of fees: Market practice is for management fee to step down post investment period (often to invested cost or NAV). From the LPs perspective this be perceived as relatively high fees, as sometimes GP seek to continue collecting management fees during extensions, or the fee base figure is higher than NAV, or else valuation subjectivity. The economics in a tail-end fund (fees/ carry) warrant close scrutiny.
Overall, tail-end funds can present challenges for investors, and it is important to carefully consider the options available to investors when dealing with these assets.