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Secondaries Proliferate as Buyout Deals Mature

The secondary market in private equity stakes continues to grow, as investors and sponsors manage complex portfolios.

The secondary market for private equity stakes is growing quickly, reflecting the growth of the primary market and the desire of investors and fund managers to actively manage their portfolios.

Secondaries provide something for those with a variety of interests: fund managers eager to sell assets and move on; limited partners intent on taking profits; and investors interested in snapping up mature, secondary positions.

Secondary deal volume likely topped $35 billion last year, according to Greenhill Cogent, the secondary advisory unit of New York investment bank Greenhill & Co., after a record high of $42 billion in 2014. Analysts say last year’s decline reflects the vagaries of deal timing and doesn’t represent a trend.

Alternative-assets research firm Preqin says the volume of deals in the primary private equity market averaged $362 billion annually from 2007 to 2010, the vintage years for many secondary positions. That provides plenty of raw material for secondary deals.

The secondary private equity market saw its largest transaction ever in November, when the California Public Employees’ Retirement System (CalPERS) sold its stake in 43 real estate funds to Blackstone’s Strategic Partners Fund Solutions unit for $3 billion.

In the past, LPs sold private equity stakes only when they needed liquidity in times of stress. “But now it’s an efficient, normal way for investors to manage their portfolio,” says Luca Salvato, a partner at London-based secondary fund manager Coller Capital.

In CalPERS’s case, it is shrinking the number of private equity managers it uses to about 45 from 150. Other investors are taking similar steps. “Limited partners are liquidating portfolios to reallocate into core strategies,” Salvato says. “They’re cleaning up aging portfolios and often aren’t re-upping with the existing manager on a new fund.”

Investors can sell private equity stakes today just like other asset classes, such as stocks and bonds, says Brett Gordon, managing director of secondaries for HarbourVest Partners, a private equity fund manager based in Boston. “The most sophisticated investors look at selling within their private equity portfolio like everything else,” he says. “They aren’t afraid to make buy-and-sell decisions.” Selling decisions are rarely connected to the quality of the assets, Gordon says. It’s more about changing allocations or reducing manager counts.

Meanwhile, investors who buy stakes in secondary private equity funds may gain an asset with some visibility, since funds selling their positions have usually invested 70 percent to 80 percent of their capital. And secondary-stake buyers enjoy a quicker payout, since secondary funds generally purchase positions that are at least four years old. Private equity funds generally last ten years. Secondary funds are usually fully invested within two years, compared with three to five years for a primary fund.

“Investors’ portfolio distributions come back quickly, so they get a good balance between their secondary portfolio and their longer-dated holdings,” says Nigel Dawn, head of New York–based Evercore Group’s private capital advisory group. “Secondaries lower the risk of private equity, because of the good visibility on the assets being purchased and the fact that an investor is not going out too long.”

General partners of private equity funds are driving the growing number of secondary transactions, as they seek to wind down funds with small, old positions and open new ones with bigger profit potential instead. GPs also may seek to swap LPs to bring on board investors with whom they have relationships or ones they think will provide more capital. Industry estimates indicate GP-led secondary transactions totaled $12 billion to $15 billion last year, up from about $7 billion in 2014, according to Coller Capital’s Salvato.

The geographic focus of secondary positions mirrors the distribution of primary private equity deals, analysts say. The U.S. accounts for 50 percent, Europe 42 percent, and Asia 6 percent. The Asian portion could reach 10 percent within two to three years, thanks to rapid growth in the primary market in recent years, Dawn says.

The industries represented in secondary positions run the gamut. Analysts expect to see growth in real estate, infrastructure and credit strategies in coming years. “Real estate has lagged private equity in liquidity,” Dawn continues. “But as more capital is raised to invest in real estate, there will be more competition for assets. That means pricing gets better, and it’s more attractive for sellers of secondary positions.”

Dawn and others expect the secondary market to continue expanding, just as the primary market is growing. Secondaries still represent a fraction of the primary market’s volume, which totaled $545 billion last year. “I think there will be strong growth going forward, because there’s a real need for making what has been an illiquid asset more liquid.”

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