Secondaries and a Twitter hoax

In late April, hackers seized control of the Associated Press’ Twitter account, and reported that President Barack Obama had been injured in explosions at the White House. 

Almost immediately, the Dow Jones Industrial Average dropped 145 points, briefly erasing $200 billion of value from the market. The AP very quickly reported that the information was fake, admitting to the world that its Twitter account had been hacked. And the market quickly recovered, even closing the day a few points higher than it had been at the opening bell.

The rapidity with which the market lost value was largely a result of the algorithm-based programmes that automatically trade stocks based on scans of news headlines, according to the Wall Street Journal. And these days, that includes Twitter – especially since the US Securities and Exchange Commission authorised public companies to release material information via the micro-blogging site earlier this year.

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Christopher
Witkowsky
 

What’s significant about this episode is that it shows how fragile the current market really is. The recent rally in US equities appears to be built more on the willingness of the Federal Reserve to continue pumping capital into the markets, rather than those boring old economic fundamentals that ought to drive better markets (like higher employment, consistent export growth, rising manufacturing output, and so on). In the absence of these strong fundamentals, the stock market rally is currently standing on very shaky ground.

So what does any of this have to do with the private equity secondary market?

Public market performance has a powerful influence on secondaries market activity, because it’s a major driver determining whether an institutional investor becomes a seller of limited partner stakes.

As we reported in May, pressure comes off institutions to sell LP stakes when public markets are strong. Equities usually constitute the biggest slice of an institution’s investment portfolio – so when they’re performing well, the value of the entire fund goes up. This, in turn, may leave investors under-allocated to private equity due to the denominator effect, because illiquid securities now account for a smaller percentage of the overall portfolio (like the issue that afflicted many LPs in the wake of the credit crisis, only in reverse).

In this situation, an institution that starts selling LP stakes leaves itself potentially even more under-allocated to private equity – which is arguably not the way to go in a low interest rate environment where yield is so hard to find.