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Investors Now Pay Full Price for Second-Hand Private Equity

Discounts used to be the norm. No longer.

Buying another investor’s interest in a private equity fund used to mean getting a discount. But investors that have done so over the past six months are paying full value.

The median secondary transaction closed at 100 percent of net asset value, with the mean slightly lower at 98 percent, according to Palico’s latest survey of limited partners that successfully transacted in the six months ending September 30. 

The latest statistics on secondary transactions reflect how the market has evolved. In addition to traditional fund buyers of secondary private equity stakes, pensions and large family offices are increasingly competing for transactions, driving up prices. At the same time, investors are drawn to secondaries to diversify away from the “blind pool” nature of private equity. When investors commit capital to a new PE fund, they know little about their future investments. Prices are also healthy as private equity firms have raised record amounts of cash for new funds.

As a result, even global economic uncertainty and concerns around tariffs and trade haven’t dampened the appetite for deals. 

“Pricing has held remarkably steady despite recession concerns, supported by record amounts of dry powder,” according to Palico’s latest survey, which includes 40 private equity funds, including those focused on buyouts, growth, venture capital, real assets, and credit.

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Firms that specialize in secondary stakes are using a record amount of leverage — a trend that has kept prices high. 

“Secondary specialists are also calling on growing amounts of leverage to juice returns in today’s intensely competitive marketplace; one secondary market adviser recently estimated that leverage in the form of loans, deferred payments and preferred equity accounts for a record 45 percent of volume this year, up from just 4 percent in 2013,” according to Palico’s most recent report. 

Fund stakes that sold at par or more closed at a 6 percent premium above net asset value, According to Palico, the premium is one-fifth above the level reported in its previous survey. 

Still, investors are being more discerning in the secondary market. With higher volatility, the gap between the most popular funds and everyone else is slowly widening. According to Palico, about 50 percent of secondary stakes in funds sold at par or better over the last six months. In the second half of 2018, 63 percent sold at par or better. 

Older funds are dropping in popularity. 

“Over the last six months the number of tail-end funds (vehicles that are at least 10 years old) have dropped from a third of the secondary market to 24 percent. As investors become more selective, they are buying fewer tail-ends. Older funds hold fewer investments, increasing risk relative to younger more diversified portfolios,” according to the study. “Overall, the average age of funds sold over the past six months is 6.8 years versus 7.6 in Palico’s last study.” 

If activity continues to be strong in the secondary market, this year could end up in a record. Palico reported that some experts believe the forsee $90 billion to $100 billion in secondary volume. As a percentage of the overall private equity industry, secondary activity is still small, coming in at about 1.6 percent of the $5.8 trillion in total PE assets. 

“When private equity’s biggest weakness is arguably illiquidity, it certainly leaves a lot of room for growth,” wrote the Palico reports authors.

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