I know PE firms get capital commitments excess of the total capital the fund will invest all its life. How does this relate to individual investors?
Ex.
a $1.5bln fund is started with 26 investors(A-Z) committing 100 million each(total committed cap = 2.6bln).
Along the life of this fund only 15 investor's capital is called. The remaining 11, have their money tied up and not realizing any alpha return as a result.
Am I missing something? Sounds kind of like a bad deal for investors, I wouldn't want to have $100m waiting for a PE cap call which may never come. Why wouldnt investors just fork it over to a hedge fund which would put that money to immediate use?
If you weight the return on a capital commitment, would it really be worth it? For example, theres a 15/26 chance investor Z's capital will be called. Expected return of this fund is 25%.
(correct me if my assumptions/logic is wrong)
Fund Size: 1.5bln
Cap Com: 2.6bln
Expcted Rtn: 25% (of 1.5bln)
Rtn: $375mln (.25 x 1.5bln)
2% mgt fee: -$ 30mln (.02 x 1.5bln)
20% CI fee: -$ 75mln (.20 x [1.5bln x .25])
Cash To Inv: $270mln
Eff Rtn: 18% (270mln/1.5bln)
This is the effective return to an investor whose capital has been called. Now adjusting for prob of not being called(obviously VERY simplified):
Will Call: 15/26
Not Call: 11/26
Called Rtn: 18%
No Call Rtn: 4% (US Treasuries)
Weighted Expected Return: .18(15/26) + .04(11/26) = 12.1%
Thats not including tax effect on ROI. Is this ballpark-accurate? Obviously the fund distributes cap calls across all investors so they draw from all 26, but the same logic still applies (instead of 15 out of 26 investors having their capital called, 15/26ths of investors cap-com is called)
My understanding was that they wouldn't call 15 of 26, they would call 26 and divide the 1.5 over that figure. Drawdown periods are limited to 3 years or so, so capital wouldn't be tied up past that. I get the logic in investing in hedge funds rather than committing to a drawdown over 3 years, but at the same time, it's a totally different investment vehicle. It has the risk of negative returns, fund exploding, etc., which are risks that are a lot more rare, if not non-existant, in PE circle. Also, CI would be charged above a hurdle, so in your case, if they return 25%, and hurdle is 8%, the first 8% are to investors, the remaining 17% is split 80/20, changing the return to investors.
That makes sense... I knew I must have been missed a piece of the puzzle.
So in that case the fund size would actually be 2.6bln, mgt fee would be based off of 2.6bln as well? But at any given time they only have 1.5bln in play?
I understand the varying risk profiles of the 2 vehicles, was just confused at how unattractive PE capital commitment seemed from my (flawed) understanding.
I would think that mgmt fees are based off capital drawdown, not committed. It just seems to not make any sense to drawdown $500 mil in a yr, with $3 bln committed, and charge 2% of $3 bln, equal to $60 mil or 12% of actual capital available to invest.
Mgt fees are based off of total committed capital. Investment periods are typically first 3 years. Capital is drawn down pro-rata, therefore each investor gets the same deal. However, sometimes founding, or special, investors can get a better deal on the carry. Funds try to fully invest the fund but usually leave plenty of room for future Mgt fees for the life of the fund, e.g. 10 years of mgt fees.
fund investors don't just have the uncommitted capital sitting in the bank or invested in treasuries. they have it at work in similar or other asset classes. They just have to be 'good for it'. With big institutions, this becomes somewhat actuarial where portfolios are balanced so there's always funds available for generally-predictable capital call velocity.
And I'm confused by the $1.5B vs. the $2.6. If the firm raises $2.6B of capital commitments, it's a $2.6B fund. And all (most) of it should eventually get invested, less a little head room as another poster mentioned. At least that's the intention.
And like someone else mentioned, the capital calls are pro-rata. The mgmt fee is on the committed capital, but the specifics of the fund documents will determine how long that will last and then what stepped-down rate will apply to invested capital futher in the fund's maturity, etc.
that is not how it works at all... First pro-rata and second it's rare that large amounts of capital are uncalled, you call substantially all of it before raising the next fund.
Tip: Verify basic assumptions before trying to model out a completely fictional PE world.
Generally, depending on the fund, I think the target use is generally above 80% of the raised fund. I know we try and hit about 85 or 90 percent of committed capital and leave the excess for management fess and/or potential future add-on acquisitions.
I was reading an article which stated PE firms typically secure $2 of committed capital for every $1 of invested capital and obviously misinterpreted it. The numbers didn't quite make sense to me, thats why I'm verifying my fictional PE world.
Thanks for the quick PE lesson everyone.
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