
The life cycle of a closed-end, private drawdown fund can be described in three stages: investment, operational enhancement, and harvesting.
The life cycle of a closed-end, private drawdown fund can be described in three stages:
Investment period (typically years 1-3)
- Fund manager identifies investment opportunities, calls capital as needed, and deploys capital to targeted investments.
- Returns are usually negative. Investments are typically valued at cost.
- Net cash flow is generally negative, as more capital is called than distributed.
Operational enhancement period (typically years 4-7)
- This is the “alpha” or “value-add process,” when the fund manager helps drive revenue growth, increases the profit margin, and improves the capital structure.
- Returns go from negative to positive because distributions have begun, and the fund’s investments are written up to “fair value.” Fund manager fees typically switch from being based on the amount of committed capital to the amount of “invested” capital (e.g., capital account balance).
- Net cash flow turns positive as distributions outweigh any remaining capital calls.
Harvesting mode (typically years 8+)
- The fund begins selling its investments in earnest, which may take years given their illiquid nature and the fund manager’s motivation to sell at a high price.
- Returns are at their highest point but may taper off a bit as the fund’s remaining investments and the associated fees decline, and the time value of money impacts the IRR calculation.
- Net cash flow is positive due to distributions from income, return of capital, and realized gains/losses.
Key takeaway: Understanding the life cycle of a private fund can help investors better understand:
- How a portfolio’s allocation to private investments can change over time.
- How investing in private funds requires long-term planning, which includes modeling future cash flows (e.g., capital calls and distributions).
- How vintage year diversification can smooth out a portfolio’s cash flow by allowing distributions from older vintages to fund capital calls from newer vintages.
How CLA can help with private fund portfolio construction
When you’re looking to maintain and grow assets for business investments, we can help customize a diversified portfolio to help you achieve your dreams. Contact our wealth advisory team for personalized assistance.
Private placements are not available to all investors. This blog is purely for educational purposes and does not constitute an offering or advertisement of any kind.
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