Over the past five years the secondary market for stakes in closed private equity funds has gone from strength to strength. Pricing over the last half-decade has been remarkably attractive for sellers, with the average price – expressed as a percentage of net asset value – never dipping below 91 percent. This illustrates strong long-term secular demand.
Commitment levels to secondary funds and market volume have steadily grown since 2012. Although volume dipped slightly to $39 billion last year from a record $40 billion in 2015, largely due to depressed net asset values at the start of 2016, some $12.3 billion in stakes were traded last quarter. At that pace, 2017 would see a record of more than $49 billion traded in the secondary market.
Buying secondary stakes – through specialist funds or directly – is now widely seen as an attractive means of improving portfolio liquidity. With the core of the market composed of funds that are seven to eight years old, secondaries are typically liquidated in four years. Buying also reduces overall portfolio risk, since funds sold on the secondary market hold assets that can be evaluated, unlike fundraisings. While investors generally forego the exceptional two-times-or-higher multiples on invested capital achieved with the best primary investments, secondary returns are more predictable and cluster in the 1.4 to 1.7 times invested capital range.
Private equity fund portfolios are structured to be held to term. Arbitraging easily and rapidly between investment opportunities, as happens with stocks, bonds and other standardized investment instruments, is not a feature of bespoke private equity. All of this means private equity secondary volume dries up if average pricing is not relatively close to fund net asset value. Far from the occasional marketplace of a decade ago, when deals were often discounted fire sales, today’s vibrant secondary volume is a function of strong demand and attractive pricing for sellers.
With a record $84 billion of uninvested capital held by secondary investment specialists and the secondary pockets of funds-of-funds, further growth of the secondaries market seems assured. The ranks of secondary buyers are also expanding beyond specialists. A recent Palico survey of 106 private equity investors – all members of Palico’s marketplace – shows that 40 percent are shortening their decision making processes in order to take advantage of fast-moving opportunities to buy secondary stakes. While investment committees may meet quarterly or even biannually to consider private equity investments, secondary transactions can take a few weeks from start to close.
The Palico marketplace allows investors to anonymously post private equity fund stakes for sale and reach out to buyers. Those fund stakes are viewed by the largest buyers community in the world (some 2,754 accredited investors are Palico members), maximizing secondary value and transfers. Mainstream or specialty vehicles, first-time funds, co-investments, ‘final call’ fundraisings seeking those last few commitments, and secondaries – all are easy to find and filter on Palico.
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