If nothing else, The Carlyle Group knows how to shake things up.
The firm has figured out a way to give limited partners in its sixth fund liquidity long before the end of the fund life. It has recruited five secondary shops – Coller Capital, Landmark Partners, Partners Group and the secondary units of both Goldman Sachs and Credit Suisse (all of whom made unspecified primary commitments to Fund VI) – to serve as preferred buyers for LP stakes, if and when a Fund VI LP wants to sell.
Carlyle will price interests twice a year, using the average weighted value of all bids required to meet the supply of available interests. The highest priced bids will be matched first with the available interests to determine the final price.
The arrangement is pretty flexible. Carlyle can end the programme at any time, and the five preferred buyers can walk away at any time. Equally, LPs can accept offers for their fund stakes from elsewhere.
Carlyle launched Fund VI in March with a target of $10 billion, and according to Bloomberg, which first reported the early exit option, the structure was included in the firm’s private placement memorandum.
A few things have been made clear from my discussions with numerous industry sources about this. The first is that Carlyle has come up with an innovative way to meet a long-held concern of LPs: the lack of liquidity in traditional private equity funds.
There appears to be two schools of thought on the move.
The old school argument is that private equity is fundamentally long term in nature, and LPs who aren’t comfortable locking up capital for many years shouldn’t get into the asset class in the first place. A path to quick liquidity sounds “hedge fundy”, one source told me.
The old school argument is that private equity is fundamentally long term in nature, and LPs who aren't comfortable locking up capital for many years shouldn't get into the asset class in the first place.
This is the view of the private equity “purists”, who have probably been in the asset class for multiple years and understand that, unlike hedge funds, private equity capital takes time to seed and grow. They also understand that a lock-up means just that – an LP isn’t going to see that capital for several years at least. Entering that kind of partnership takes some courage, especially through cycles like that which occurred after Lehman Brothers collapsed.
The new school sees the structure as potentially the start of a trend. Here the argument is that certain LPs have become much more active in terms of managing their portfolios. They aren’t afraid to trade in and out of positions and try to be as opportunistic as possible.
To those within this school of thought, the industry has been changing fundamentally since the financial crisis broke in 2008. Many limited partners discovered the rigid nature of the asset class didn’t work for them, as they needed cash to pay bills and meet obligations. Private equity was a necessary part of their portfolios to get the kind of returns they were targeting, but the inability to get liquid quickly left them anxious and even helpless in the face of obligations.
These investors want to be in private equity. But they also want options. Carlyle has figured out a way to give them options.
Certain kinds of LPs have a more traditional view of the asset class – and so are only just waking up to the possibilities of managing their private equity portfolio. Some, like the California Public Employees’ Retirement System, or the state pension system of New Jersey, have made use of the secondary market to shift the focus of their programmes – reducing exposure to certain GPs in order to build up relationships with others, or simply to make room for new vehicles.
Whatever school you fall into, Carlyle deserves (and is getting) plaudits for coming up with a way to meet the demand of at least a certain group of LPs – those who recognise that the asset class doesn’t have to be illiquid, and that they can be a more active participant.
In fact, this is a model that other GPs are likely to follow, because LPs will continue to ask for it. As the asset class matures, LPs are growing alongside it. And they will continue to look for new ways to manage their portfolios, shedding their previously passive approach for something much more proactive and opportunistic.