Cash flows in private markets funds

When you invest in a private market fund, the cash flows (i.e., the timing of when your money is invested and later returned to you) are very different from when you invest in a public fund, such as a mutual fund.¹ This article will explain in simple terms why that is, and use real data to help you set realistic expectations for your private investments.

Investing your money

Starting from the beginning. The first major difference is rather than putting your money immediately into existing assets, private managers invest the capital you committed to their fund at their discretion, typically over multiple quarters. The money you agreed to invest is not actually transferred to the fund manager immediately. Instead, it is “called” by the manager when it is actually required to make investments.

This has the benefit of allowing you to continue to invest the money you committed to the fund while awaiting these “capital calls”. However, you must be ready to send cash to the manager as and when these calls are made. Typically notice periods are relatively short - sometimes less than ten days - and there may be penalties for failing to meet your obligations. Investors must therefore think carefully about their level of liquidity before committing to a private market fund.

Returning your money

While capital may initially only flow outwards, it is important to remember that the money is being actively put to work acquiring assets and generating value. But it may take time for you to see that value in the form of cash via gradual “distributions”.

While private market funds vary in terms of how they invest, the assets they hold are not traded on an exchange. This means for many (though not all) strategies, a fund manager must actively create value, which takes time. For growth-focused strategies, holding periods for their underlying investments vary, but are typically several years, while the manager executes a value creation plan and waits for an opportune time and method by which to exit the investment and make a profit for the fund. With investments staggered over time, so will be the cash coming back to you.

Cash flows over a fund life

In basic terms, over the lifespan of a fund cash flows gradually tilt from only going out to (eventually) only coming in, and by the end the distributions (hopefully) far outweigh the capital calls. 

Precisely how long that tilt takes varies by strategy, though almost all private market funds should be approached as long-term investments and demand patience. Let’s look at two private strategies at either end of the lifespan spectrum: early-stage venture capital - which is necessarily one of the slowest strategies to invest and return capital - and senior private credit - which is one of the quickest.

The illustrative chart below compares the capital calls with the distributions made by early-stage venture capital funds that started investing in 2011 - the 2011 “vintage”.  It should be noted that many of these funds may still be making distributions. Every vintage is different, as funds buy and sell investments in different environments, but this chart shows:

1. The median early-stage venture fund launched in 2011 took more than six years to deploy 90% of committed capital.

2. The median fund took over 10 years to break even, before delivering 50% more cash in the five quarters that followed.

3. An upper quartile (75th percentile) fund, in terms of distributions, broke even after eight years, but had returned more than 2.3 times committed capital as of the latest available data. With good venture funds, patience is a virtue.

By comparison, sticking with the 2011 vintage, the chart below shows net cash flows (the balance between paid-in capital and distributions) for private credit funds focused on senior debt. These funds generally invest in assets that produce income via cash interest, which may accelerate distributions. This is reflected in the data, which shows that the median private credit fund took far less time than the median early-stage venture fund above to reach net positive cash flows: six-and-a-half years rather than ten.

Good things come to those who wait

Given these differences, it is important for you to understand the likely cash flow profile of a particular fund strategy prior to investing so you know when you should expect to reap the rewards of your patience.

Private investments may not be suitable for every investor, but for those that can lock up some capital over longer time horizons, these funds may be able to complement existing exposures and enhance a well-balanced portfolio.