The Zombie Fund Crisis in Private Equity: Unlocking Liquidity in a Stagnant Market

The private equity industry, once a beacon of high returns and long-term value creation, now faces a quiet but existential crisis: the proliferation of "zombie funds." These underperforming vehicles, which outlive their intended 7–10 year lifespans, have become a systemic threat to limited partners (LPs), locking up capital, eroding returns, and distorting market dynamics. In 2025, as valuation gaps widen and exits stall, the pressure on LPs to seek liquidity through secondary sales and public market alternatives has never been greater.

The Systemic Risks of Zombie Funds

Zombie funds are not merely underperforming—they are structurally broken. By extending beyond their original terms, they continue to charge management fees (typically 2%) while failing to deliver meaningful returns. For institutional LPs like pension funds and endowments, this creates a double whammy: capital is trapped in illiquid assets, and fee drag compounds the erosion of returns. Consider the math: a $1 billion fund charging 2% annually generates $20 million in fees per year, even if it has no active investments. Over a 15-year lifespan, this fee drag totals $300 million—money that could have been reinvested elsewhere.

The risks extend beyond individual funds. Zombie funds distort industry benchmarks, making it harder to assess the true health of private equity. They also crowd out active funds in a market already starved for capital. With $3.3 trillion in global demand for private capital and only $1.1 trillion in available supply, zombie funds exacerbate the scarcity of quality opportunities. Midsize firms, lacking the diversification of industry giants like KKR or Apollo, are particularly vulnerable. Firms such as Trilantic Capital Partners and Onex have resorted to continuation funds and secondary transactions to prolong their underperforming vehicles, but these stopgaps often come at the cost of dilution and regulatory scrutiny.

Valuation Gaps and the Illiquidity Trap

The root of the problem lies in valuation gaps and delayed exits. In 2025, private companies—especially those in later stages—struggle to justify public market exits. The median gain for PE-backed companies going public in 2024 was 20.7%, compared to a 6.8% loss for VC-backed firms. Yet, many PE-backed companies remain stuck in limbo, unable to meet the growth metrics required for IPOs. This has forced LPs to pivot to secondary markets, where they can sell stakes in underperforming funds or portfolio companies.

Secondary transactions, however, are not a panacea. While they offer liquidity, they often come at a discount. For example, university endowments—now major sellers in the secondary market—have increased their activity in 2025 to offset lost research grants and prepare for potential changes in their tax-exempt status. These institutions, known for their deep understanding of asset value, tend to hold out for competitive pricing, limiting the potential for steep discounts. Meanwhile, buyers remain selective in a "buyer's paradise" environment, where macroeconomic uncertainty and regulatory shifts (e.g., the SEC's push for quarterly fee disclosures) heighten scrutiny.

Strategic Diversification and Proactive Governance

For LPs, the path forward lies in strategic diversification and proactive governance. Diversification means rebalancing portfolios to include public market alternatives—such as listed private equity vehicles or infrastructure ETFs—that offer liquidity without sacrificing returns. For instance, the S&P Global Infrastructure Index has outperformed the S&P 500 in 2025, offering stable cash flows and lower volatility.

Proactive governance, meanwhile, requires LPs to engage more rigorously with GPs. This includes:
1. Rigorous Due Diligence: Assessing fund performance beyond the first nine years and scrutinizing fee structures.
2. LP Advisory Committees (LPACs): Leveraging these bodies to push for fee holidays, independent valuations, and transparent communication.
3. Secondary Market Utilization: Actively exploring secondary sales to unlock trapped capital, even at a discount.

Consider the case of a pension fund that recently exited a zombie fund via a secondary transaction, recouping 70% of its capital. While this was below the initial investment, it allowed the fund to reinvest in a high-yield bond portfolio, which generated a 9% annualized return over the next two years. Such strategic pivots are critical in an environment where liquidity is scarce.

The Road Ahead

The private equity landscape in 2025 is fraught with challenges, but it also presents opportunities for those who act decisively. Zombie funds are a symptom of a broader market imbalance—one that can only be corrected through disciplined governance, diversified strategies, and a willingness to embrace public market alternatives. As regulatory pressures mount and macroeconomic uncertainties persist, the ability to unlock liquidity will separate resilient portfolios from those left languishing in the graveyard of illiquidity.

For LPs, the message is clear: adapt or be left behind. The future of private equity depends not on chasing returns in stagnant funds, but on building ecosystems where capital flows freely and efficiently.