A quick look back at the stories sister publication Secondaries Investor covered last year and one thing is clear: the secondaries market continues to innovate and evolve.
During a year punctuated by macroeconomic volatility and political uncertainty, the buyer and seller landscape has been evolving to deal with increasing competition, rising levels of leverage, and high pricing, to name a few.
Deal volume for the full year fell to $37 billion from $40 billion, the lowest level since 2013, according to advisory firm Greenhill Cogent, which cited fewer deals of $1 billion or more in size. This marks the second year in a row of declining trades.
Yet headwinds such as public market volatility, Brexit and the US election have failed to dampen secondaries players’ spirits; rather, they appear to have driven market participants to find more off-the-beaten-path deals.
One such deal was HarbourVest Partners’ hostile £1 billion ($1.2 billion; €1.2 billion) takeover bid for SVG Capital, a London-listed private equity vehicle. The deal dragged out over a nail-biting five weeks as competitors including Goldman Sachs and Canada Pension Plan Investment Board launched counter offers, and ended in mid-October when SVG capitulated to Boston-headquartered HarbourVest’s offer to acquire the vehicle’s portfolio instead of its share capital.
Market participants heralded the deal as a new era in the sector, with the head of European secondaries at one firm likening the deal to the “corporate raider” transactions of Wall Street.
Infrastructure secondaries have been making headlines too, such as Arcus Infrastructure Partners’ €800 million tender offer on its 2007-vintage fund in March, and Ardian’s sale of its AXA Infrastructure Fund II, a 2007-vintage €1.1 billion vehicle.
Excluding real estate, real assets secondaries such as infrastructure, energy, timberland and agri, and metals and mining exploration, show real promise.
The buyer and seller landscape has been evolving across all asset classes, as an October survey of limited partners globally by Private Equity International found. Almost a third of respondents said they plan to increase purchases of fund stakes over the next 12 months, a sign the already competitive secondaries market may become even more crowded.
Buyers have become sellers, such as Partners Group’s sale of an €800 million portfolio of tail-end private equity stakes to Goldman Sachs, and sellers have become buyers, such as Michigan Retirement System’s purchase of a $25 million stake in Warburg Pincus Private Equity XII.
“People always had these [buyer or seller] labels,” says Phil Tsai, global head of secondaries market advisory at UBS. “That has increasingly become more and more blurred.”
In real estate, an asset class secondaries buyers are arguably most excited about, the buyer and seller labels there have yet to blur, and the buyer universe remains limited to a handful of dedicated players.
“Despite the relative attractiveness of the market, there still aren’t a lot of new entrants into the space,” says Sarah Schwarzschild, head of real estate secondaries at Metropolitan Real Estate. Pension funds and sovereign wealth funds have not built up dedicated real estate secondaries teams in the same way they have in private equity because real estate is still a specialised space, she adds.
As for complex deals such as fund restructurings where assets are moved into new vehicles with reset economics and terms, at least five of these closed in 2016, a sign players in the space are applying the same tools as their private equity counterparts, Schwarzschild says.
“The traditional (real estate) LP fund market is not going anywhere and will always exist,” she says. “These other types of asset secondaries deals, fund recaps, there’s a lot of buzz around them and they will continue to be prevalent.”
Despite early macroeconomic headwinds and political uncertainty, the amount of capital raised for secondaries hit a record high last year.
Fundraising for dedicated secondaries vehicles alone across private equity, real estate and infrastructure rose to $33.9 billion from $23.5 billion in 2015, an increase of more than 44 percent, according to PEI data.
Paris-headquartered investment firm Ardian raised the largest pot of capital ever for the strategy with its ASF VII fund, which included $10.8 billion for secondaries, and Blackstone’s Strategic Partners amassed a cool $7.5 billion for its Fund VII in December. With HarbourVest Partners, Pantheon and Partners Group also holding final closes on their flagship vehicles, the top five funds that closed during the period totalled more than $29 billion in committed capital, representing more than 86 percent of the total capital raised in 2016.
Not only are the top secondaries funds growing in size, the average size of funds is also rising as fewer vehicles raise more capital. Secondaries funds have almost quadrupled in size over the last eight years, with 23 vehicles closing on an average of $1.5 billion last year, compared with 22 vehicles closing on an average $376 million in 2008, according to PEI data.
With high levels of dry powder – as much as $105 billion, according to advisory firm Lazard’s estimate – competition for deals has increased, and this will lead to lower returns on transactions, according to a partner at a New York secondaries firm. Ten years ago, buyers were underwriting diversified multi-million dollar portfolios at around a 20 percent unlevered return the partner said. This has dropped to around 10 percent today, the partner added.
“For private equity in general, if you talk to any LP they certainly expect returns to come down,” he said. “Secondaries are certainly not immune to that.”
One segment market participants have been excited about for a while is the growing GP-led sector, which rose to account for a quarter of the market by volume last year, up from 20 percent in 2015, according to advisory firm Greenhill Cogent.
Funds that were raised during the pre-crisis boom are reaching the end of their decade-long life cycles, and restructurings and other GP-led transactions are one way to breathe new life into such funds.
One notable GP-led transaction last year was the staple deal involving Lee Equity Partners’ 2009-vintage, $1.2 billion debut fund. AlpInvest Partners led a group including the Canada Pension Plan Investment Board, HarbourVest Partners and Pantheon which bought stakes in Lee Equity Partners’ first buyout fund and committed to the firm’s latest vehicle. The group of investors purchased about $900 million worth of stakes in the fund and committed around $300 million to Lee Equity Partners Fund II in a deal that was nominated for PEI’s Secondaries Deal of the Year in the Americas.
The quality of restructuring assets – such as the Lee Equity staple – has been inching up, according to HarbourVest managing director John Toomey, who focuses on secondaries investments.
“A few years ago, it was mostly distressed managers or distressed assets, but now higher quality managers are getting more opportunistic with higher quality assets,” Toomey says.
Limited partners pushed back on some transactions last year, most notably when energy-focused private equity firm First Reserve attempted to restructure its 2006-vintage $7.8 billion fund. The process was scuppered after California Public Employees’ Retirement System, described by one source as “an influential and upset LP”, expressed doubts about the proposition.
Failed deals aside, GP-led processes continue to be seen as an attractive and growing part of the secondaries market despite the overall decline in deal volume. As one London-based managing director at an advisory firm focusing on GP-led transactions told PEI: “You can have a very good year in a slightly declining market from a volume point of view, it just depends on where you position yourself.”
AGAINST THE TIDE
Pricing for fund stakes inched down throughout the year, with average high bids falling 1 percentage point to 89 percent of net asset value compared with the previous year, according to a January report by Greenhill Cogent. Despite this, buyout and venture funds rose, with 1 percentage point and 3 percentage point gains respectively.
The firm attributes the rise in buyout pricing – to 95 percent from 94 percent of NAV – to strong demand for 2010 to 2015 vintage funds, with some buyers bidding at double digit premiums for stakes in such vehicles.
Higher quality venture assets and stable public markets were some of the drivers that pushed pricing for venture funds to 78 percent from 75 percent of NAV, the firm wrote.
Lower exposure to unicorns – start-ups valued over $1 billion – in venture funds last year also contributed to the pricing boost: buyers tend to see such investments as having limited potential upside and may generally bid lower for unicorn-containing funds, according to Wes Bender, a principal in the firm’s Dallas office.
Despite a second annual drop in deal volume, 2016 was the third biggest year of secondaries trading ever, and the firm predicts deal volume will hit a record high in 2017 due to strong pricing and a record amount of dry powder chasing lower dealflow.