While a ten-year term is a common feature of private capital fund Limited Partner (LP) agreements, funds usually take significantly longer than ten years to fully liquidate; these “zombie” assets can continuously shuffle along through multiple extensions.[1] For LPs who are considering selling zombie assets onto the secondary market, the big question is: are General Partners (GPs) clinging to these overstated zombie valuations, and thereby postponing eventual write-downs, or should LPs ultimately expect this capital to be distributed in full? In this blog post, we present evidence that zombie assets are, on average, appropriately valued.

Key Takeaways

On average, “zombie” assets are liquidated at prices that are in line with GP valuations.
Funds that outperformed in their first ten years tend to continue outperforming with zombie assets, realizing higher returns than peer funds after age ten.
For risk management, LPs should be conscious of the substantial probability of write-downs, even though this is not the expectation.

We call a fund a “zombie” if, at age ten, its reported net asset value (NAV) is at least 10% of the original commitment amount. There are a couple of reasons why some LPs may think that GPs are systematically overvaluing zombie assets: GPs may be overoptimistic, or they may be strategically trying to extract more fees for the same work.[2] Once fund NAV drops to 1% of the commitment, we consider it to be quasi-liquidated, at which point we can evaluate whether GPs had intentionally overvalued their zombie assets. One way to test these valuations is to look at the internal rates of return (IRRs) for funds in their zombie phases, as illustrated in figure 1.[3] An IRR of zero means the valuation at age ten was exactly right, a positive IRR suggests that the assets were written up, and a negative IRR suggests that the assets were written down. We find that, in expectation, IRRs are above zero in all three asset classes (Venture Capital, Buyout, and Real Estate); however, median IRRs are closer to zero.[4] This data demonstrates that GPs are relatively accurate when valuing zombie assets.

*Fig. 1: Probability density of IRRs from age ten until 1% quasi-liquidation. Solid red lines denote pooled IRRs; dotted red lines denote medians.*

While the average fund appears to be accurately valuing its holdings, LPs may worry that this is untrue for funds that underperformed during their first ten years. Using fund private market equivalents (PMEs) from inception to age ten, we divide funds into “good funds”—funds that outperformed public equities[5]—and “bad funds”—those that did not. Figure 2 suggests that, in expectation, even bad funds distribute their reported NAV in full, but good Real Estate and Venture Capital funds significantly outperform. While these findings are encouraging for LPs with zombie exposure, a word of caution: the risk of large write-downs is substantial, and this risk is greatest for bad funds, as evinced by the meaningful mass of funds with negative IRRs since age ten. Approximately 30% of bad funds yield zombie IRRs below -10%, compared to just 20% of good funds.

Fig. 2: Distributions of IRRs from age ten until 1% quasi-liquidation. Funds with since inception PMEs greater than 1.0 at age 10 are classified as “good funds,” while the rest are “bad funds.” Solid vertical lines denote the pooled IRRs of good and bad funds; dotted lines denote medians.

Conclusion

Despite concerns that GPs might overstate valuations of “zombie” assets, we find little evidence that this is a systematic practice. Even underperforming funds appear to be accurately valuing their zombie assets, on average. However, risk managers should keep in mind that there remains substantial potential for write-downs, especially among funds that have already underperformed.

*The author would like to thank Brooke H. Jones and Henry Phan of Bryn Mawr College for valuable discussions on the topic.

[1] Using an overly simplified measure of fund life, from age ten, the average zombie Buyout fund takes another six years to quasi-liquidate. The number is similar for Real Estate funds but rises to over eight years for zombie Venture Capital funds. These numbers likely underestimate fund lifetimes because funds that have yet to quasi-liquidate have unknown final ages, so the ages we can measure are biased toward zero.

[2] For instance, GPs may be able to extract additional compensation if there is a post-investment period management fee based on invested capital. Alternatively, a manager raising a new fund may try to inflate returns of previous funds at the margin.

[3] Between the Venture Capital, Buyout, and Real Estate asset classes, the Burgiss Manager Universe (BMU) contains 7,247 funds as of October 2022. Here, we are looking at 1,604 quasi-liquidated funds that meet our “zombie” criteria. An additional 1,199 funds are currently in their zombie phases but have yet to quasi-liquidate, so we exclude them here. Only 435 funds were quasi-liquidated by age 10, while another 800 reached age 10 with a residual value of less than 10% of the fund size. The remaining funds are under age 10 and still active.

[4] This is a predictable and common result in private capital, where returns have a long right tail.

[5] As determined by a Kaplan-Schoar PME of greater than 1.0.

How Accurate are “Zombie” Valuations?