Another banner year for secondaries

The first six months of 2011 were record-breaking for the secondaries market, which is poised to hit an all-time high this year, writes Christopher Witkowsky.

The buying and selling of positions in private equity funds – as well as the other transaction types which make up the secondaries market – has over the years become a mainstream component of the private equity industry. And it is poised to continue its growth.

That was underscored earlier this week when it emerged that roughly $14 billion in deals were done in the first half of 2011 alone, making it the most active six-month period ever in secondaries history. A number of factors have been driving the activity, including financial institutions divesting their holdings ahead of regulatory changes, limited partners streamlining portfolios, captive groups spinning out and even hedge funds liquidating side pockets which held fund interests and direct assets.

Just this week, for example, Paul Capital revealed a complex €70 million transaction and a $65 billion US pension reported that it had sold stakes in several mega-funds.

The flurry of activity has coincided with – and has also been caused in part by – a rebound in public market valuations. That rebound in turn has impacted net asset values and caused pricing discounts to narrow. According to a half-year pricing report published by Cogent this week, the average high bid for buyout funds was 91.6 percent of NAV. Pricing has risen over the past two years from the lows of the first half of 2009, when bid prices averaged 39.6 percent of NAV. The market commanded simple average first round high bids of 84.5 percent of NAV during the first half of 2011. The higher pricing has prompted a number of sellers, who’d  been unwilling to take the steep discounts seen immediately following the financial crisis, to sell private equity assets and fund interests.

Meanwhile, secondaries firms have been collecting large amounts of dry powder to deploy. Lexington Partners most recently closed its seventh secondaries fund on $7 billion in June, while Coller Capital is raising $5 billion and firms focused on the smaller end of the secondaries market, such as Unigestion and Greenpark, have recently closed or are raising new vehicles.

Market participants wave away suggestions that all the capital being raised could outpace dealflow, noting a steady supply of various transaction types was expected to continue barring a significant macro event disrupting global markets.

Secondary players also dismiss the notion that their edge is diminished when discounts become smaller or non-existent, as they are today for top-quality fund interests. The strategy will continue to resonate with institutions keen to more quickly build their exposure and have capital returned, as buying highly funded assets means an LP is waiting three to four years for liquidity as opposed to six to seven years, according to one European secondary fund manager. He added that it also remains a means of building a lower-risk portfolio, given the high transparency on assets being purchased and their proximity to exit.

With both buyers and sellers active and confident, the secondaries market is poised to outpace last year’s record $23 billion or so of transactions. For anyone who may still think secondaries an insignificant part of the private equity industry, 2011 activity is likely to change their mind.

Private Equity International takes an in-depth look at the secondaries market in its forthcoming September issue.