Outlook 2012: Secondaries

More than $20bn of secondary transactions are expected for both 2011 and 2012, with macroeconomic uncertainty continuing to mute the growth of deals, says PineBridge’s Harvey Lambert.

Private equity secondaries transaction volume is on track to surpass $20 billion in 2012, according to head of private equity secondaries at PineBridge Investments, Harvey Lambert.

Secondary volume during the first six months of 2011 reached levels that had investors predicting “a very big year”, according to Lambert, but the number of deals fell in the second half of the year due to global macroeconomic uncertainty.

“The bid ask spread widened in the last six months due to buyers requiring a greater risk premium given the increase in macro-uncertainty, and as a result, transaction volume will not be as robust as the first half of the year,” Lambert said. “I think what we’re going to see next year is something similar to what we saw this year, which is north of $20 billion in volume.”

Lambert admits he was surprised at how high pricing for secondaries became during the first six months of 2011, but was relieved when sellers “priced things back into reality” in the second half of the year.

Harvey
Lambert

“Pricing was getting somewhat aggressive, particularly for the larger transactions with brand name funds,” he said. “I was happy to see that prices quickly reflected what was going on in the market. It was a bit like cold water being thrown on a fire that was overheating.”

While investors early in 2011 were pricing secondaries at return expectations that were not reflecting the risks they were taking, Lambert says, that is no longer the case.

“I think that the market and buyers are on alert right now to what is going on in the global economy and I think pricing will be a good reflection of risk over the next year,” he said.“But that will probably mean that sellers are going to have to accept the fact that there’s more uncertainty in the world and pricing will have to come down.”

One new development that will potentially change the complexion of the secondaries landscape next year is the impact of zombie funds, when underperforming GPs string out the life of existing funds to continue raking in management fees.

“We’re continuing to see the growth of these zombie funds,” he said. “LPs are getting increasingly anxious about owning these funds in their portfolio because the alignment of interests are starting to diverge and it’s going to continue to grow.”

Secondary firms, however, are well-equipped to address the issue, Lambert added.

“I think what you’re going to start seeing is LPs in these zombie funds using the secondary market to exit their positions [and] the GPs of these funds using the secondaries market to get another bite at the apple to basically try and reset their carry and realign incentives,” he said. “I haven’t seen a lot of this happen yet, but I think it’s going to start.”