Over the last three months, we have been fielding questions from buyers and sellers and comparing notes with clients, as everyone attempts to gauge the temperature of the secondary market. Since this crisis hit, there has been a degree of paralysis on the part of vendors as they have attempted to understand the valuation environment.
The fastest bear market in history and a gravity-defying rebound has made it difficult to understand the direction and velocity of travel of private market asset prices; this is made all the more uncertain given doubts over the longevity of the current V-shaped public market rally. To top it all off, record-high unemployment and plummeting demand show a gaping disconnect between the stock market and economic reality.
Recent months have been a lot to take in for investors in private equity funds. LPs have been left wondering how much their assets are really worth, both today and on a forward-looking basis. This has made it difficult for some secondary deals to make it over the finishing line.
However, there are signs that the market is beginning to thaw. Net asset value (NAV) reports for March 31st began to stream through in April and May, providing some visibility on the initial impacts of the coronavirus pandemic on assets. There is still a high level of uncertainty and, therefore, a natural bias among vendors to seek liquidity from funds that are earlier in their lifecycle. For these funds, which have less or no capital drawn, NAV valuations are less of a consideration, making deals more straightforward. For this reason, this deal type is likely to feature prominently through 2020.
We can also expect to see an uptick in activity in more mature funds in the latter half of the year. This will be helped by greater clarity on asset valuations around mid-July, once 30th of June NAV reports come in. This will show how PE portfolios fared during Q2, which for the majority of European and US businesses will be the most punishing quarter in living memory.
This will provide a much-needed touchstone that should see offer prices draw closer to NAV, resulting in more closed transactions. With more visibility and less risk on the table, buyers will be less motivated to build heavy discounts into their bids and, depending on world events over the next two months, should be more eager to deploy their capital to avoid missing an opportunity, especially if the economy shows encouraging signs.
Deal flow should also be supported by historically high levels of inventory. There is an estimated $4trn in private equity assets under management on behalf of LPs, which represents both dry powder and invested capital. Starved of yield, private equity has become a larger percentage of overall portfolios over the past decade. This means there is no shortage of asset value for potential liquidation as LPs prune their portfolios in the second half of the year, motivated by the need to rebalance their portfolios, make strategic shifts, or raise cash for liquidity purposes (and potentially reinvestment opportunities).
This mass of PE stock also means that the secondary market has plenty of headroom for growth over the next cycle. Government and central bank stimulus will mean yield remains elusive and private equity will be an increasingly critical returns-enhancing component to investor portfolios, as it has in the years following the global financial crisis.
Limited partners that require liquidity can take comfort in the knowledge that there is an unprecedented appetite for secondary deals. Record secondary dry powder of anywhere between circa $50bn and $200bn, depending on whose estimate you accept and whether leverage is factored in, is creating welcome upward price pressure for sellers, despite the macroeconomic environment. We also see that blockages in the traditional fundraising market may create further demand. Investors seeking to increase their exposure to PE may turn to the secondary market as it offers LPs on the buy-side a shortcut into private equity.
After an understandably muted start to what has been a highly exceptional 2020, signs point to a busy second half. This should build momentum for what has all the makings of a record year in 2021.
As always, stay safe and well out there. Do not hesitate to contact us with any questions or insights you’d like us to explore or discuss - you can reach me directly by replying to this email or at email@example.com.
Palico is the leading digital marketplace for private equity secondaries. Our digital platform is designed for LPs, from single Family Offices to large Pension Funds, to streamline the secondary sales process, and maximize price with an array of both traditional and non-traditional PE buyers on the platform.