Limited Partnership Interests
Market Description (Continued)
Limited Partnership Interests
Limited partnerships are legal entities which are comprised of general partners, who manage the day-to-day operations of the business, and limited partners, who have invested capital in the business. While they may be utilized for other purposes, limited partnerships have become the dominant structure for private investment funds, allowing investors to participate financially, but with no exposure to personal liability. Some of the earliest limited partnerships were formed in the US to raise capital from investors for railroad expansion.
When we speak of Limited Partnership (LP) interests, for the most part we are referring to ownership rights in alternative investment vehicles such as private equity funds (including venture capital, buyout, mezzanine and real estate funds), hedge funds and funds of funds. Estimates indicate that the limited partnership interests represented by ownership in fund vehicles is a $2+ trillion market. In summary, 10,000+ hedge funds managed roughly $1.4 trillion in assets at the outset of 2009, and private equity assets under management (AUM) represented approximately $1 trillion managed by 4,000+ funds.
Over the past several years the secondary market for the $2 trillion in limited partnership interests has grown tremendously. The secondary market is expected to grow at an even more rapid pace as many limited partners seek to reduce their alternative investment exposure. Many limited partners are requesting redemptions or simply seeking to get out of their positions largely due to a need for capital, a desire to rebalance their portfolios as well as poor fund performance. However, many are locked into their positions for years or are unable to receive capital distributions due to redemption restrictions.
Limited Partnership Liquidity
For the majority of hedge funds, investors are typically locked up for a 1-year period, after which they generally have the ability to withdraw capital on a quarterly basis with 30-60 day advance notice before quarter end. Hedge fund investors, facing economic uncertainty and mounting losses, have requested record redemptions in the past quarter. One estimate by Hedgefund.net puts investment losses at $185 billion in Q4, with redemptions at $471 billion in the same period. As investors head for the doors in droves, many funds have invoked so called “freeze” and “gateway” provisions, locking investors into the funds indefinitely as they scramble to sell illiquid assets in a somewhat orderly fashion. This has blocked the typical exit strategy of most limited partners in hedge funds, with the secondary market remaining as the only potential option for liquidity.
The situation with venture capital (VC) and other private equity (PE) funds is slightly different. The typical life cycle for a PE/VC fund is 10 years and investors do not have withdrawal or redemption rights. When a PE/VC firm starts a new fund, limited partners make a capital commitment, which is called over time as the fund manager makes investments. Ideally, investors in these limited partnerships are committed investors and intend to fulfill the commitment over the life of the fund. However, changes in asset allocation, cash flow needs, management, ownership, strategy, regulations and economic climate all can lead to the need to seek early liquidity.
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