Private equity firms have attracted millions of investors to tie up their money into various fund that run for about 10 years, or more. The private equity firms keep a part of the profit and fees, of course. If results are good, investors sign up for another decade. But according to the Wall Street Journal, more than 200 of roughly 10,000 funds raised during the past decade have returned far less money than was originally entrusted on them. And these dead funds manage a whopping $100 billion, says The Economist. Many industry experts say the sum will balloon in future. So, they qualify as zombie funds. 

Private equity

Zombie funds – these are undead funds that tie up investors’ hard earned money and keep charging them fees even when there is little hope about profiting from the remaining assets. These funds have no chance of raising fresh capital for future funds. According to investment professionals, any private equity fund that lasts longer than its predetermined period and a two-year extension, is a zombie fund.

There is no profit, no future, but they survive on 1-2 percent fees charges on the assets. If they are going through a worse phase, they start charging a consulting fee to the companies they own. Zombie funds are ubiquitous today simply because of the way private equity firms are structured. Investors put their money and stay in the background, mainly for tax purposes. They can’t withdraw their money at will because they are forced to wait until the fund’s predetermined lifetime expires.

Many investors have complained that such moribund funds place highly inflated values on the remaining, hard to sell assets. Pension funds that form a majority of private equity investors, that results into inflated management fees and inaccurate valuation of assets that will be used to pay retirees like firefighters, teachers and other employees.

The Securities and Exchange Commission is digging into these issues to know if investors are being misled. Bruce Karpati, the asset-management enforcement unit head of SEC said that the regulators are looking into the zombie private equity funds that might have stale valuations.

People who have already tied up their money have few options. One option is to persuade the fund manager to shut it down and distribute shares of the remaining assets. But that results into a heap of hard to sell assets, like stock certificates for private companies. What can you do with that?

Investors have one more option of selling their stakes. But the stakes in such undead funds trade about 30-50 percent below the valuations placed by zombie fund managers.

The horror of zombie funds is likely to continue in the future.

H/T AbnormalReturns