Secondary considerations

St. James’s Square is a well-to-do part of London, usually bustling with businessmen and gentry heading to and from meetings.

But a visit to Pantheon Private Equity’s offices there in late December found the square abnormally quiet in the few days before Christmas. Elly Livingstone, a partner at Pantheon, was one of those to have not yet fled the capital in favour of cosier, festive surroundings. This may be because, as the head of a global secondaries team in fundraising mode, he has a lot on his plate.

Of the 65 investment professionals at Pantheon, 25 focus exclusively on secondaries and these are spread across New York, San Francisco, London and Hong Kong. The geographical spread, says Livingstone, is vital. “It has always been a global business; you can’t just think of it as Europe or the US,” he says, adding that a Japanese institution could be selling a stake in a US-based fund to a buyer in Europe. 

The mention of Japan leads on to a particular area of interest for Pantheon. With the emergence of private equity markets across Asia – something that the global financial crisis could have arguably accelerated – the continent is occupying more the team’s time.

“It’s evolving quite quickly, because the pace of fundraising into Asia picked up radically in 2005 and 2006,” he says. Because Asia remains a “bright spot” in terms of where institutional investors want to allocate capital, he continues, the flow of institutional capital “is bound to work through to secondaries activity, and in fact already is.”

The Asian market has historically accounted for between 4 and 5 percent of the firm’s secondaries activity, but that figure is set to grow. It has been present there since the early 1990s. “We see it as a growth area, both in its own right and relative to Europe and the US,” says Livingstone, “We could imagine the proportion of activity growing towards 10 percent of the total over time.”

Pantheon’s secondaries activity began informally in the late 1980s. The firm’s listed fund, Pantheon International Participations, acquired a global portfolio of assets that resulted from the break-up of the UK Water Authority. “There had been a few deals that had been done at that time, but no one really knew what they were,” he says. “Buying unlisted assets – where investors had these assets and needed liquidity – was not really thought of as an asset class.”

Pantheon’s position as both a secondaries manager and primary fund investor – a position shared by such competitors as Goldman Sachs and HarbourVest – means the firm’s secondaries team is viewed in an increasingly favourable light by GPs, says Livingstone. This is because a GP introduced to the secondaries team may well be able to cultivate a valuable relationship for future fundraisings with the primary team. “If you are a partner and you are talking to someone who can potentially invest in your fund, then that is an interesting conversation to have … particularly in a tight fundraising environment,” he says. A secondaries transaction has become a “marketing opportunity” for some GPs.

So while GPs are thawing to the idea of secondaries funds as serious – and potentially fruitful – partners, are institutional investors getting comfortable and allocating capital to secondaries funds? The fundraising market has naturally suffered from the crisis in the same way that the primary market has. Many liquidity-starved LPs have been forced to slow or halt new commitments to the asset class. Ironically, the very presence of liquidity-starved LPs has served as a reminder that secondary funds play an important role in the market, and thus deserve investors’ attention. “Investors want liquidity, and in the last year investors have been reminded that this asset class can suddenly become very illiquid,” says Livingstone.

Livingstone declines to discuss Pantheon’s own fundraising position, but a filing with the US Securities and Exchange Commission in December showed that the firm has raised just shy of $1 billion for its fourth secondaries fund – Pantheon Global Secondary Fund IV. Successive SEC filings show that it had garnered almost $600 million worth of these commitments during 2009 on its way to a stated target of $3.75 billion. If Pantheon were to reach its target, it would have one of the largest pools of capital for secondaries investment in the market. Goldman Sachs raised the largest dedicated fund in 2009: the $5.5 billion GS Vintage Fund V. Other notable pools of secondary capital include Coller Capital’s $4.8 billion 2007 fifth fund and the $2.7 billion that Lexington Partners has reportedly raised for its seventh fund, which has a target of $5 billion.

Livingstone plays down the suggestion that a splurge of money raised recently for investment in secondaries would have sated LP demand for such funds. “People talk a lot about the money raised in the secondary market,” he says. “It comes down to a bifurcation: specialist capital in the hands of dedicated teams on one hand, and those who are opportunistically dipping in and out on the other. The capital raised in the hands of dedicated specialists – yes there are a couple of large funds out there – has grown, but it’s not an exponential growth by any means. And it’s nothing compared to the growth in the primary market.”

Parallel to the increased interest shown by LPs in the secondaries market runs the widely held – and now somewhat debunked – perception that out of the chaos of the financial crisis would emerge a feast of opportunities at knock-down prices for the secondaries buyer. This was only half-right, says Livingstone: “We had a tsunami of conversations. But 2009 was curious in that while deal flow surged, the actual number of completed transactions was down on 2008.”

Livingstone expects the market to return to a more “normalised” state in 2010. There are institutions, particularly in the banking sector, which will need to address their private equity allocations, but can now afford to do so in a more “thought-through” manner.

“The banks have exposures through their leverage sponsorship groups, perhaps some fund commitments and perhaps some direct investments,” he says. “Banks had so much to deal with in 2009 that their private equity allocation came low down on their priority list. I think as we move into the next year or two, there will be a need to shrink balance sheets and reduce exposure.”

Pantheon recruited “heavily” during 2008 and, says Livingstone, he will continue to add to what he describes as a tight team. Having built his team, Livingstone gives the impression that his tenure at the firm has in many ways been building up to this “coming-of-age” market for secondaries funds. “I have been here for a decade,” he reflects, “and my job here is just beginning.”