Private Equity: Episode 8 - The Liquidity of a PE Fund

In Episode 7, we discussed the different ways to access Private Equity funds. I introduced the option of life insurance, which provides liquidity at any time to the investor, albeit at the cost of higher fees. Today, let's focus on the liquidity of Private Equity funds.

Generally, a Private Equity fund is designed with a long-term objective, and its duration is set for at least 5 years, which can extend up to 10 years or more. It’s important to note that these funds are often closed-ended, meaning that investors cannot sell their shares before the fund is liquidated.

To mitigate this constraint, the first solution introduced was the emergence of a secondary market (Private Equity Secondaries). This market, which has two distinct approaches, creates liquidity for investors:

1. The fund may sell one of its holdings to another fund, thereby generating cash which can be distributed to the investors.
2. Investors themselves may sell their shares directly to others.

In recent years, new solutions have emerged, such as evergreen open-ended funds. These funds have an unlimited lifespan, allowing investors to enter and exit whenever they wish. In these situations, it’s up to the fund manager to carefully manage cash levels to ensure there are enough resources to handle investor withdrawals.

To ensure liquidity, these funds are often required to invest in assets that are sufficiently liquid and low-risk—generally outside of Private Equity—to allow for quick liquidity recovery if necessary. However, this mechanism can negatively impact the fund’s performance, as it prevents the fund from fully investing in the highest-return assets.

Finally, some startups are currently developing blockchain-based solutions aimed at creating secondary market exchanges (similar to stock exchanges) to allow investors to resell their fund shares to each other. While promising and supported by the European Union under the Pilot Regime, these solutions will not be fully functional for a few more years.

For now, it's important to remember that Private Equity is a relatively illiquid investment, which is not a problem in itself, as it is inherently a long-term investment where capital gains take time to build.