Despite the ebbs and flows of the world’s public equity markets, secondary pricing for private equity funds has remained remarkably stable over the past two years, with the average discount to net asset value of top bids hovering near the 10 percent mark since mid-2010.
Today there is every reason to believe that secondary pricing is more insulated than it has been in the past from public market swings. There is also plenty of reason to believe that secondary pricing versus net asset value will narrow further for all but end-of-life secondary directs.
The average discount today in the secondary market for PE funds is around 9 percent, but more than 60 percent of funds are trading at discounts of less than that, with many selling at par or even at small premiums, according to Palico estimations.
Bringing that overall average down are relatively large sales – often amounting to hundreds of millions of dollars – of so-called secondary directs. With average hold periods for portfolio companies lengthening to record levels in excess of 5 years, many limited partners anxious to monetize long-in-the-tooth funds, are selling en-masse to new LPs who set the clock back to zero on these portfolios, receiving discounts of 15 percent or more as an incentive to do so.
But for the bulk of the secondary market, pricing has actually tightened in recent quarters. The secondary space has grown from an occasional market ten years ago with annual volume of about $3 billion to an increasingly active arena where volume is forecast to hit a record $30 billion this year. That demand should hardly be surprising: mature secondary interests have a lower risk profile than primary opportunities – usually blind pools – because they hold assets that can be evaluated.
There is plenty of dry powder earmarked for secondaries – in excess of $60 billion is held by secondary funds and funds-of-funds, according to industry estimates. That is a positive for sellers, but tight pricing is arguably more a function of attractive offers than strict supply and demand calculations. For all but perhaps some of those end-of-life fund interests mentioned above, the market has evolved from one characterized by distressed, liquidity-driven sales, to one driven by opportunistic portfolio pruning and tweaking that just does not happen without attractive prices for sellers.
A roughly equitable division of benefit between buyer and seller is essential to closing secondary private equity fund transactions, since private equity is the only asset classes where returns are not predicated on trading strategies and where portfolios are structured to be held to maturity. Buyers must share benefits in a way that is simply not necessary in asset classes where investment strategies incorporate arbitrage assumptions.
This exceptional dynamic is becoming increasingly evident. It may explain better than anything else why secondary pricing has remained stable versus the relative volatility of secondary markets in other asset classes.