Great piece by Jason Zweig of the WSJ on the trouble with private equity funds: Trying to get your money out.
For years now, big banks and brokerage firms have been urging their wealthiest individual clients to get into private-equity funds. Buying such a prestigious fund can make you feel like a big cheese with privileged access to the high returns corporate deal making can generate. Trying to sell one, however, can make you feel like a tiny mouse in a giant glue trap.
Consider J.C. Flowers II L.P., once one of the most glamorous of the buyout funds. By July 1, investors must decide whether to stick with the fund, which has lost roughly 60% over its life, or sell their stakes to a group of buyers for less than three-fourths of its shriveled value.
Investors face two risks. If they sell now, they lock in an even more severe loss than they have already suffered. If they hang on, they gamble that the manager can turn the fund around, while having no idea how much longer they will have to wait to get their money out.
It’s instructive to see how investors ended up in this bind.
Launched in 2006 by the firm led by J. Christopher Flowers, formerly a top banker at Goldman Sachs, J.C. Flowers II sought to raise $3.5 billion.
As the financial bubble peaked, Flowers practically had to beat investors away with sticks. Lured by the success of the firm’s first fund and the hope of giant gains from buyouts of banks and other financial companies that Mr. Flowers knew so well, money came pouring in.
J.C. Flowers II closed the floodgates at $7 billion. Among its investors were such giants as the Andrew W. Mellon Foundation, the Colorado Public Employees’ Retirement System, the Teachers’ Retirement System of the State of Illinois and the University of California. A number of wealthy individuals bought in, too.
Before the fund could get all that money invested, the bubble burst. Flowers also made some unfortunate investments, including MF Global, the brokerage firm that collapsed and sought bankruptcy protection in 2011, and Tokyo-based Shinsei Bank, which has fallen more than 60% since the fund bought it in 2008.
Scheduled to earn a 1% annual management fee and 20% of profits, Flowers cut its yearly fee to 0.9% after the losses. It hasn’t kept that 20% cut of investors’ profits, because there aren’t any.
The latest transaction may change that. The new investors in the fund, Coller Capital of London and Goldman Sachs Asset Management of New York, are acquiring their stakes at a 27.5% discount from the fund’s already depressed value as of March 31.