Faster deployment doesn’t help investments perform well

Fund managers’ freedom to deploy capital on their own timeline is instrumental to how well their funds perform, according to a study by alternative investments technology firm eFront.

Data from the firm’s report Interpreting Drawdowns: The Data Lens published in December show an inverse relationship between the capital deployed in the first year of a fund’s investment period and the eventual performance of the fund.

Looking at US leveraged buyout funds from 2000 to 2008, funds deployed more capital on average in the first year of the fund’s life (29 percent), then slid to about 20 percent in the second and third years, and declined regularly from the fourth year onwards.

When comparing deployment pace in the first year across these vintages with eventual performance of the fund, eFront found a negative 0.32 correlation. This means that when a manager deployed more capital in the first year, its performance declined.

The report noted that “pressure from investors” to put cash to work has resulted in a faster investment pace in the first few years of the investment period.

The consequence of having “less freedom” in deploying capital, however, is not having the time to invest in the “best opportunities”. Even though fund managers usually have a pipeline of potential deal opportunities when they raise new funds, there is no certainty as to when these opportunities will materialise. What’s more, putting pressure on managers  to deploy capital could result in them selecting investments they would normally have passed on, according to the report.

“This analysis debunks some common assumptions about drawdowns,” Tarek Chouman, chief executive of eFront, said in a statement accompanying the report. “One of them is that fund investors have put an increased pressure on fund managers to deploy more capital faster.”

Given that most of the fund regulations cap the capital deployed in any given year at 25-30 percent of the committed capital, it is difficult to see how fund managers can deploy faster, Chouman added.

“What is also clear from the analysis is that having the freedom to deploy or not is an important tool to invest for fund managers.”

In addition, the pressure to deploy capital does not necessarily translate into more efficient cash management for LPs. The increasing use of subscription credit lines means that even if fund managers actually invest, this does not necessarily translate into immediate capital calls, the report found.