Even some of the top quartile funds raised during the credit bubble will struggle to generate carried interest for fund managers, according to new research from Oxford University.
Carried interest typically kicks-in when a fund’s internal rate of return passes a guaranteed eight percent internal rate of return “hurdle” for investors. The average fund raised during 2006-2007 is currently producing an IRR of around two percent, according to data drawn from Private iQ, an industry database.
We have a situation where even the worst funds get carry when the conditions are benign, and many of the best funds won't get carry when the market conditions are less favourable
The final performance figures of boom-era vintage funds will “all depend on how markets (and cash realisations) develop”, said Oxford University professor Tim Jenkinson, who presented the research at a recent Duff and Phelps conference.
In contrast, even the worst-performing funds with a 2003 vintage and most funds with a 2004 vintage have cleared the eight percent hurdle. Cheaper deals and lower leverage ratios for companies during these years could account for the stark performance difference, said Jenkinson. The average buyout fund raised in 2005 is currently producing about a seven percent IRR.
“We have a situation where even the worst funds get carry when the conditions are benign, and many of the best funds won't get carry when the market conditions are less favourable,” said Jenkinson.
Accordingly, LPs are increasing the amount of due diligence conducted on GP performance when making new commitments, said one funds lawyer. “Having the right vintage year won’t be enough, they want to see what made you stand out from the others,” said Dante Leone of Milan-based law firm Capolino-Perlingieri & Leone.