Private equity fund investors are bracing for a surge in so-called zombie funds, with more than half expecting their portfolios to contain more of these funds within the next two years. This represents a significant increase from 28% in 2024 who anticipated an uptick. A zombie fund occurs when a money manager extends a fund's life beyond its original expiration date, primarily to maximize management fees, trapping limited partners' (LPs) capital in illiquid assets with diminished returns. This trend is largely attributed to the difficulty in selling assets acquired at inflated prices during a period of low interest rates, which has now reversed with the US Federal Reserve's rate hikes since 2022.
The private equity industry has experienced a broad slowdown in dealmaking due to higher interest rates. This has, in turn, squeezed cash distributions to fund investors and made it more challenging for private equity firms to raise new funds. Despite hopes for a deal comeback in 2026, market uncertainty and concerns about AI's impact on private software firms have stymied buyouts, leading to a decrease in global deal count in the first half of the year, according to a Bain & Co. report.
Eric Foran, a partner at Coller Capital, which surveyed 108 private capital investors worldwide overseeing approximately $2 trillion in assets, noted that the expected rise in zombie funds was higher than he would have anticipated. These funds present a dilemma for investors, who typically prefer non-confrontational solutions, such as requesting a reduction in management fees or revising economic terms to encourage earlier exits. Continuation vehicles, which involve rolling existing holdings into new funds with fresh capital, are also seen as a mechanism for managers to avoid burdening existing investors with aging assets, with two-fifths of fund investors expecting their use to increase.
While investors are concerned about zombie funds, their commitment to private markets remains resilient. A third of LPs expect to accelerate their rate of commitments, and 57% foresee their pace remaining stable over the next two years. However, there is an increasing selectivity among LPs, with almost a quarter planning to reduce the number of general partner relationships in their private markets portfolios over the next three years, up from 16% in 2020. This indicates a strategic shift as investors navigate a complex landscape characterized by geopolitical uncertainty, liquidity pressures, and scrutiny over portfolio quality.
