Secondaries: Macro in mind

When Private Equity International recently asked more than 300 private equity market participants to rank their biggest concerns, macro issues dominated: Brexit, negative interest rates and a Trump presidency emerged as the top three.

Such concerns have weighed on secondaries market participants over the last 12 months, and for a sector that is often said to respond well to market dislocations, the headwinds have had varied effects.

Secondaries deal volume for 2015 dipped slightly to $40 billion, having peaked at $42 billion a year earlier, according to Greenhill Cogent, which cited fewer deals closing in excess of $1 billion. This slowdown, driven by an accelerated decline in crude oil prices, the S&P 500’s worst start to a year, Brexit and growth fears in China, continued into 2016 with the investment bank estimating a 20 percent drop in transaction volume during the first half, its lowest level in three years.

But the dip in deal volume does not signify a deceleration in the overall secondaries market, according to Bernhard Engelien, a managing director in Greenhill’s London office. He says that while there were only two $1 billion-plus deals during the first half of the year, activity is shifting to the middle and lower end of the market, as well as to GP-led transactions, which increased to around 30 percent of the market in H1.

“Everyone is trying to specialise a little bit and develop an edge,” Engelien says. “The market is quite segmented. The larger players look at the large deals and there’s a fair amount of deals which are anywhere between $30 million and $200 million that may not always be attractive for the larger buyers.”

One of those large buyers is Ardian. The Paris-headquartered firm isn’t concerned about a slowdown in dealflow at the top end, with the firm’s US head telling PEI it carried out advanced due diligence on $15 billion-worth of potential $1 billion-plus deals in the first half.

“This segment is the most interesting for us as we have limited competition in this area,” Benoît Verbrugghe, head of Ardian US says. “There are only a handful of players in the market with the required knowledge and capacity to bid on such deals.”

Ardian has also been busy on the fundraising front, holding the final close in April on $10.8 billion for its ASF VII vehicle. For its part, Ardian does not believe its landmark fundraise means capital raising in the secondaries market has peaked. Rather, investors are becoming better educated about the strategy, and as the market continues to mature, even more investors will become attracted to it, Verbrugghe says.

Political uncertainty and macroeconomic concerns do not appear to have affected fundraising over the last 12 months, with 20 dedicated secondaries funds closing on around $29.6 billion between September last year and early August, according to PEI data.

One trend set to continue this year is a growing rift between higher quality funds and those perceived to be of lower quality, according to a report by Credit Suisse.

Indeed, pricing has risen to near record-high levels, with median pricing for private equity fund stakes at 95 percent of net asset value during the second quarter, the second-highest quarterly level ever, the bank found.

“The secondaries market continues to bifurcate in terms of those seeking to access high-quality LP positions at prices around NAV and those seeking diversity in tail-end portfolios, with steeper discounts and use of structuring to generate their returns,” says Mark McDonald, head of EMEA and Asia secondaries advisory at the Zurich-headquartered bank.

Market participants at the beginning of the year also pointed to an expected rise in dealflow for real assets secondaries, with the massive collapse in commodity prices and the increasing acceptance of deals in related asset classes expected to spur transactions. Energy-related secondaries deals in particular were expected to boom, as potential sellers realise the drop in commodity prices was more than just a blip and seek liquidity for their investments.??

“As a buyer with expertise and the capital to put to work in that strategy, that’s an interesting place to be right now,” Jeff Keay, a managing director at HarbourVest Partners, told PEI in April.

As of press time, the uptick in energy secondaries still seemed a little while off – a second half story at least. Energy and infrastructure stakes accounted for just 2 percent of funds marketed by Greenhill Cogent during the first half, smaller than any other strategy.

Real estate appears to have fared better. Deal volume in the asset class accounted for one sixth of total market volume and annual growth has been in excess of 30 percent between 2012 and 2015, according to data from Landmark Partners.

“Over the past few years, the real estate secondaries market gained a lot of visibility and validation,” says James Sunday, a partner at Landmark Partners. “This, coupled with LPs’ increasing desire to more actively manage denominator issues, rebalance between different sectors and strategies, and reduce number of GP relationships, should lead to significant transaction volu-mes looking forward.”

Looking ahead, macroeconomic challenges continue to weigh heavy on market participants’ minds. Wouter Moerel, a managing director at AlpInvest Partners, expects there will be a cyclical economic downturn in the next year or two, telling PEI in April the LP portfolio market would thus become more attractive as leverage becomes harder to obtain and pricing reduces.

Others point to the mismatch between record high levels of fundraising and the drop in deal volume in the first half.

“Historically, the market for supply and demand has grown in lockstep; the value of deals cleared in the market is replaced by new capital raised in the market,” says Adam Howarth, managing director and co-head of private equity secondaries at Partners Group. “This may be the first year where the one-to-one ratio is off and there is more capital raised than transaction volume completed. It is still too early to call this a trend – this year might just be a blip.”

One thing is certain: political risk and its effect on public markets will remain a big theme, and a sharp correction would lead to a drop in pricing and sellers becoming less active, according to Greenhill’s Engelien.

“You have elections in the US in November, elections in France and Germany next year,” he says. “Public markets obviously react to political developments and that could certainly have an impact.”