Hedge funds — facing forced margin calls and investment redemptions — are selling off wide swaths of their private equity-type investments in search of cold hard cash.
And private equity firms have been only too happy to scoop them up. Hedge funds’ private equity portfolios are the result of a convergence of private equity and hedge funds that began about three years ago. At that time, hedge funds started participating in private equity deals in a big way. They invested in the debt layers of private equity deals syndicated by banks and also invested directly in companies in private equity deals.
Now, they can no longer afford to own these investments, which have much longer holding periods — three to six years — than typical hedge fund investments, and they are selling them off. Several hedge funds are selling interests in individual companies to co-investors and other syndicate members to pare down their positions. The more troubled hedge fund firms are offloading private equity positions in bulk, industry insiders say.
Nobody knows for sure how much of the nearly US$2 trillion hedge funds have under management is invested in private equity and what percentage of that will eventually be put up for sale. Still, a growing number of deals have been coming to market recently. So far, most of the deals have been on individual portfolio companies, said David Fann, president and chief executive officer at PCG Asset Management, a private equity consulting and investment management firm. “When hedge funds try to exit [their private equity investments] in bulk, it signifies a more significant shift in strategy at the hedge fund itself,” Fann said.
If the capital markets continue to decline, a large number of hedge funds could run into trouble, resulting in more bulk sales, he said. “As hedge funds melt down, we would expect a more bulk sale mentality,” Fann said. In the last two months, Edward Hortick, managing director of New York-based private equity firm VCFA Group, said his firm has seen a significant growth in the number of venture capital bulk sales. Hortick’s small firm usually sees only about two or three such deals per year but has already seen more than that in the first two months of this year. “There’s been a lot of margin calls, and they need the liquidity to try to fund the margin calls,” Hortick said. This is creating an opportunity for VCFA and other venture capital and private equity firms to buy hedge funds’ direct private equity investments.
These private equity sales are part of a broader sale of hedge fund portfolios, PCG’s Fann said. The private equity and venture capital firm buyers are buying these interests in portfolio companies at significant discounts, he said. For the single company deals, hedge fund executives are approaching the firms that know the portfolio companies the best. Private equity and venture capital firm co-investors generally have the right of first refusal or a first look at these deals, under their contracts. Buyers of bulk private equity have been mainly secondary private equity firms that specialize in buying portfolios of private equity-backed companies.