Hi guys,
I’m currently at a fund with 2 consecutive vintages of underperformance- asset class is special situations credit; fund doing ~10% net irr this vintage and last vintage. Currently raising fund3. Heard a partner from another team say in passing it in general would be hard for any fund to have 2 underperforming funds in a row (fair our competitor funds are showing 12-15% net irr, some higher). In this case, do you think the odds are high the 3rd fundraise will tank?
Based on the most helpful WSO content, tolerating consecutive vintages of underperformance can be challenging, especially in the competitive landscape of special situations credit. Here are some key considerations:
Performance Context: Your fund's ~10% net IRR for the last two vintages is underperforming compared to competitors delivering 12-15% or higher. This gap can make LPs hesitant, as they often benchmark against peers.
Market Sentiment: The fundraising environment for credit and special situations funds is already tough. As noted in WSO discussions, many funds are struggling due to limited opportunities, liquidity issues, and broader market challenges. LPs are becoming more selective, favoring funds with consistent outperformance.
Third Fundraising Odds: While two underperforming vintages don't guarantee failure, they significantly increase the difficulty of raising a third fund. LPs may view this as a trend rather than an anomaly, especially if the underperformance is attributed to strategy execution rather than external factors.
Mitigating Factors: Success in raising Fund 3 will depend on:
In summary, while two underperforming vintages are a red flag, the third fundraise isn't doomed if the team can convincingly address past issues and present a compelling case for future success. However, the odds are undoubtedly stacked against it in the current environment.
Sources: Q&A: 3rd Year Hedge Fund Analyst, https://www.wallstreetoasis.com/forum/hedge-fund/the-future-of-special-situations-distressed?customgpt=1, Troubled fundraising processes, Credit/Special-situation HF performance this year?
The underperformance will continue until GP valuation methodologies smarten and sellers lower their expectations.
Yes
Usually 1 vintage is okay, but two in a row is a body blow, and especially given these are the first 2 and only funds so far of a new GP (since you are raising fund 3) in the current environment this smells bad. Now 10% irr vs 12%+ is honestly not that bad (really depends on the quartile you are in, not familiar with SS), so I wouldn't say you are closing shop but expect a protractred fundraise and a down fund.
This is a good rule of thumb - 2 fourth quartile fund in a row and 50/50 chances the GP closes shop, and from there you can extrapolate how bad it is. If you have one fourth quartile fund as a blip this is okay and you can brush it off
Thank you. 3rd quartile for both funds
What are the reasons for underperformance? Did the funds just not have any winners and the average was lower or was there a BK or two thrown in?
BKs are viewed as red flags, if the former, I think firms could have the potential to navigate through it, especially with smaller funds in the LMM and MM. If the latter, that’s a very tough hill to climb.
How big were the funds? That matters a lot too.
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