Secondary consideration

LPs seem to love secondaries at the moment. Is there a danger that too much money is being raised?

It's evidently a very good time to be a secondaries specialist.

This week it emerged that Ardian (the former AXA Private Equity) has already raised $5 billion for its latest secondaries fund, after racing through its previous $8 billion vehicle, a 2012-vintage, in no time at all (it put $4.3 billion to work in 2013 alone). Meanwhile, Lexington Partners, which itself only closed its last fund in 2011 on $7 billion – a sum that seemed huge at the time – is also back in market with a successor vehicle that is likely to end up being even bigger, and is supposedly already on the cusp of a multi-billion dollar first close.

These are just two examples, of course. But they do speak to a broader trend of LP enthusiasm for this strategy. According to figures published by PEI's Research & Analytics team this week, secondaries specialists raised $22.2 billion in 2013, which means they've now accumulated $44.1 billion in the last two years. By way of comparison, they raised just $9.6 billion in 2011.

This raises a couple of interesting questions.

First, is there enough deal flow to sate these big new funds? Well, the best estimates by the likes of Cogent Partners and Setter Capital put total volume last year at around the $28 billion mark – and they suggest that the market is growing at about 10 percent per annum as LPs get more comfortable with using secondaries as a portfolio management tool. So it shouldn’t be too difficult for the handful of big funds to put two or three billion dollars to work every year, especially as more of those assets still sitting on bank balance sheets finally start coming onto the market (which some industry insiders reckon could be worth more than $100 billion on their own).

Secondaries players certainly don’t seem to be complaining about a lack of opportunities at the moment – and as long as annual fundraising is still lagging annual dealflow, the inflow of capital doesn't seem too excessive.

The second – and perhaps more significant – question is whether these funds can maintain the sort of returns they've enjoyed in the last years (which is, of course, facilitating the current fundraising boom). More capital going into the market generally means more competition, which often leads to higher prices.

Equally, the post-crisis period clearly saw some unprecedented dislocation: in the darkest days of 2008 and 2009, some steely-nerved (and well-resourced) investors were able to pick up blue-chip fund interests at bargain prices. The 20 percent stake Coller bought in stricken SVG in 2009 has since quadrupled in value as Permira’s performance has recovered, while other LPs who bought direct interests in Permira IV on the cheap will also be sitting on big gains now. Some hardy souls even bought into Terra Firma for a song post-EMI, and, we hear, are likely to do pretty well out of it. Deep discounts like these will be much harder to find in the current market, where a lot of good funds are changing hands at a premium to NAV.

That said, in a rising NAV environment like this, focusing on discounts paid can be misleading. A premium today is not necessarily a premium tomorrow; a deal priced at par might well look like a discount by the time it completes, and the price paid might look even better in a year’s time, when the funds have realised more of their underlying assets. At on the broader point, the competitive pressure on pricing is clearly mitigated by the fact that the supply of deals is growing as well as the supply of capital

So in other words: yes, there’s clearly a lot of capital being raised for secondaries at the moment. But it doesn’t feel like the kind of volumes that investors need to start worrying about. Not yet, anyway.

 

NB. If you’re interested in the secondaries market, be sure to check out PEI’s brand new specialist site, Secondaries Investor, which offers news, views and analysis from across the full spectrum of alternative asset secondaries. See secondariesinvestor.com