Unlike picking stocks, private equity investing is something of a black-box exercise. Select a GP, entrust that manager with committed capital and hope that they diligently curate a portfolio of assets that reap rewards over the coming decade. Secondaries, meanwhile, put investors in a far more transactional, hands-on role. This is where it is important for investors to fully understand the dynamics between current reported value and the potential for future upside.
It has been all quiet on the secondaries fundraising front so far this year seeing only seven final closes worth a combined $2.4bn, a considerable shortfall on the $30bn raised during the same period last year. Average fund size has also fallen by more than half from $876m in 2018 to $395m, Preqin figures show.
Secondaries fund managers are in an arms race. For the last few years, Ardian and Lexington Partners have been vying for the top spot, raising successively record-breaking vehicles to snatch up every pre-owned PE fund stake in sight. However, they’re not the only ones amassing hefty arsenals. Nine of the ten largest firms in the market at the beginning of 2019 had raised the targets on their latest flagship funds by an average of 75%, PEI data show, in a case of “go big or go home”.
Proactive communication, transparency, and fair timelines are essential to preserving investor relationships
GP-led secondaries hit a record $22bn in 2018, a 38% increase on the previous 12 months and triple the levels seen a year earlier. The momentum has continued into 2019 with H1-2019 doubling the figures from H1-2018.
Few talk about the denominator effect these days, but they soon will. For those with short memories, the phenomenon refers to the relative weighting to private equity (the numerator) in an investor’s portfolio growing by virtue of a fall in the public markets (the denominator). This skews target allocations, forcing LPs to rebalance their portfolios by selling fund positions in the secondary market.
Secondary Pricing report H1 2019
It’s time to adopt the brace position. Tough times are on the way. There are few who doubt we are now teetering on the brink of an economic downturn after one of the longest bull-runs in history.
Just under two-thirds of LPs in Preqin’s H1 2019 Alternative Asset Investor Outlook think we have reached the peak of the market.
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.