Once characterized by its scarce liquidity, the secondary market for private equity interests has evolved into a much more significant and active marketplace. The secondary markets were previously limited by a small number of buyers, distressed sellers who needed to sell assets at significant discounts to their net asset value (NAV), and general partners who were hesitant to allow the transfer of investment interests in their funds. This is no longer the case.
Transaction volume in the secondary market has risen steadily since the financial crisis, reaching $42 billion in 2014. According to the Wall Street Journal, secondary funds had roughly $55 billion of capital to spend on fund interests as of the end of 2014. An additional $20 billion was raised through mid-August 2015. This "dry powder," as well as the capital that is ready to be deployed directly by institutional investors and funds-of-funds, points to another strong year for secondary transactions, which were $15 billion in the first half of 2015 and are projected to hit $40 billion by year-end, as seen in the chart above.
Over the years, the primary motivation for sellers of private equity assets has evolved from the need to relieve financial distress to the desire to take advantage of: 1) the rising value of their private equity investments prior the final asset realization, and 2) their ability to actively manage and re-position their illiquid portfolios.
Buyers are motivated by a number of factors, including transparency, valuation and diversification. The ability to evaluate assets in an existing private equity fund potentially lowers the risk of these investments relative to a newly raised fund. Fund valuation also plays a part in the buyer's decision-making process. In many cases, fund stakes sell at a discount to their NAV -- though recent discounts are nowhere near where they were coming out of the financial crisis. In a recent report, Greenhill Cogent found that the average discount for buyout funds is 95% of NAV, while the average discount for venture capital funds is 82%. Relative asset cost also comes into play as many investors seek to purchase funds in the secondary market that allow them to pay less for their underlying portfolio investments than a newly raised fund likely would. Additionally, secondary transactions allow buyers to efficiently build portfolios that are diversified by vintage year, geography, investment stage, and strategy.
Key Takeaway: In a world that values liquidity, secondary transactions are increasingly becoming a way for private equity investors to manage their overall volatility, rebalance their portfolios, and fine-tune their exposure to the private equity asset class.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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