Earlier this week, PEI reported that Italian insurer Assicurazioni Generali was preparing another sale of private equity fund stakes, this one valued at roughly €500 million.
It’s just the sort of deal the market has been expecting, given European insurers are repositioning their portfolios in advance of incoming regulation like Solvency II, which will require them to set aside €49 for every €100 invested under its default risk model.
But they aren’t the sort of deals that have been happening. Secondaries market professionals talking to PEI in recent weeks have described a slow environment completely devoid of the large portfolio sales that defined the market – and seemed to keep coming thick and fast – over the past two years.
Cogent Partners tallied deal volume at about $3 billion in the first quarter this year, which the secondaries broker described as a return to pre-2011 levels – meaning 2013 is perhaps unlikely to mirror or surpass the record $25 billion-worth of secondaries transactions estimated to have closed in both 2011 and 2012.
The slowdown is due, in part, to the strong public markets. Potential sellers on the secondary market are less inclined to bring their portfolios to the table when stock markets are strong for several reasons. One is that it creates a reverse denominator effect, sources point out. When the equity component of an LP’s portfolio is performing well, the rest of the portfolio rises with it, decreasing the percentage of private equity relative to the overall portfolio and potentially under-allocating the institution to the asset class.
Reducing private equity exposure in this situation would further under-allocate the institution, which is a problem in and of itself and also raises the question of what to do with the proceeds, especially in today’s low interest rate environment. Considering the range of investment options, where else will investors achieve the kind of returns they can potentially reap from private equity? “I don’t have any other place that’s going to give me a return over equities; you’re not going to get it in fixed income,” Chris Ailman, CIO of the California State Teachers’ Retirement System, recently told PEI.
As markets rise, so too do the net asset values of funds, which means potential sellers become less inclined to go through the rigours of a secondary sale. It’s a catch-22 situation that one secondary investor calls the “fear and greed pendulum”. Says the source: “Nobody wants to sell anything because they think NAVs are going to continue to climb. My prediction is the minute the public market starts to become unstable and volatile, you’ll start seeing more selling.”
Institutions that continue to sit on the sidelines now may miss out on the seller’s market. Numerous secondaries
Investors will need to do some serious soul-searching, determining which side of the so-called 'fear and greed pendulum' their institution is swinging towards.
firms have dry powder stored up and ready to spend, with some funds gradually approaching investment period deadlines. With a lack of product in the market, portfolios that do go on the block are likely to generate a great deal of interest among traditional buyers and lead to potential bidding wars depending on the underlying funds and assets.
And, of course, rallies don’t last. The recent rally in US equities appears to be built more on the willingness of the Federal Reserve to continue pumping capital into the markets, rather than those boring old economic fundamentals that ought to drive better markets (like higher employment, consistent export growth, rising manufacturing output, and so on). In the absence of these strong fundamentals, the stock market rally is currently standing on very shaky ground. Indeed, just yesterday the S&P 500 hit a new high and then fell 1 percent all on the same day, a phenomenon the Financial Times points out last happened in March 2000 and October 2007, respectively heralding the end of the dotcom and credit booms.
No one knows how long this upswing in the cycle will last, but secondaries players are hoping the closely watched Generali auction will be the first of many to try and capitalise on markets while they remain buoyant. “It’s an incredible sellers’ market, and these don’t come around that often,” says one US-based secondaries market professional.
Still, these aren’t easy or quick decisions to make. Investors will need to do some serious soul-searching, determining which side of the so-called ‘fear and greed pendulum’ their institution is swinging towards.