Secondaries pricing: Behind the NAV

Buyers and sellers' expectations need to stay within touching distance of each other for a successful market.

Secondaries deals can live or die on pricing. In recent years a healthy equilibrium in the expectations of buyers and sellers has helped propel transaction volumes.

Kathryn Regan, a partner at Landmark Partners, says she expected market volatility at the end of last year to soften volumes as pricing was expected to come down. Instead, volume surged despite the equity sell-down as public markets rebounded and average pricing for LP interests softened only modestly.

The market appears on track for another record year. Greenhill estimates $42 billion traded in the first half of the year and is expecting volume to exceed $90 billion for the full year. Nearly two-thirds of funds that online fund stakes marketplace Palico analysed in a July report were trading hands at par to NAV or higher.

Yet, execution risk remains a threat, particularly with more complex deals. According to estimates by Lazard, $4 billion of complex secondaries deals failed last year, a figure likely to rise for 2019. LPs appear to be less keen on cashing out in GP-led secondaries deals: last year 81 percent of LPs sold in asset-level secondaries processes such as fund restructurings; in the first half of this year that figure dropped to 68 percent, according to advisor Evercore.

“A strong market has encouraged more transactions to come to market that may not always have the sufficient industrial rationale, plus the higher volume has made deal selection for secondaries buyers more difficult,” says Johanna Lottmann, a former director at Lazard who is moving to Park Hill’s secondary advisory group.

Overall dealflow appears to be at record levels. Hamilton Lane, which invests via its own secondaries funds and advises clients on secondaries via separately managed accounts, saw $80 billion in opportunities in the first half of the year, according to managing director Richard Hope.

Still, buyers should exercise caution as the proportion of high quality dealflow has not increased at the same rate, a managing director at a bank that invests in secondaries tells us.

At this point in the macroeconomic cycle, buyers are “looking for deals with managers that have proved they are able to navigate challenging economic situations”, says Yaron Zafir, head of secondaries at advisory firm Rede Partners.

This widening mismatch in expectations won’t necessarily thwart the GP-led market; thoughtful structuring can help bring buyers and sellers together – for example, by using deferred payment mechanisms or injecting preferred equity into parts of the portfolio.

“Sometimes LPs see that average pricing in the market is par or a slight premium [to NAV] so assume it should apply in a uniform manner across all transactions. In reality, it’s just an average with a wide variance,” Zafir says. Pricing depends on the underlying portfolio and the underlying valuations, he adds.