The order of things

The secondaries paradigm is changing, requiring better benchmarks, astute risk adjustment and savvier buyers, writes Synthetic Private Capital founder Massimiliano Saccone.

It might surprise you to find a reference to French philosopher Michel Foucault at the start of an article about secondaries. But the Greek term “Episteme” used in Foucault’s book “The Order of Things” helps me to describe the paradigm shift I see occurring in the secondaries market.

Episteme, as Foucault wrote, means the historical a priori that backs knowledge and its discourses, and represents the condition of their possibility, expanding beyond science to include all social and cultural influences.

The new secondaries episteme, or order of things, encompasses the trading methodologies and techniques that have been developed and progressively adopted and accepted over the last twenty years, but also the regulatory burdens being imposed against illiquidity and the marketing requirements for liquidity that any retail push implies.

Many recent market volume reports state that the private equity industry is poised for continued growth; expanding towards retail investors, 401-k’s and defined contribution pension schemes internationally, with diversified structures and propositions. This is bringing about a new importance to liquidity and to the role and need for well-functioning secondaries markets.

As secondaries transactions become normal practice and liquidity options increasingly important, the notion of “private” is shifting from bearing a “secretive and opaque” nuance to more neutral “not listed in the public markets”. Consequently, the definition of “fair value” is inexorably converging to the pricing levels that are instrumental to secondaries liquidity.

Performance and benchmarking standards need to adjust to realistic terms and leave aside useless propaganda refrains (does a $4 trillion industry needs a quarterly reminder of its outperformance, particularly if this is based on flawed data?).

In the secondaries transition, the crucial price-performance relation has to be re-established so that investors are able to judge performance in terms of risk premium and decide the strategy for their primary and secondaries private equity allocation based on the expected co-movement of the target portfolio with listed markets, given their risk appetite.

A more careful and rational pricing discipline is expected to derive both from the increasing number of pro-active secondaries sellers that are able to arbitrage certain pricing dislocations tied to exuberant fundraising cycles, and from a new breed of contrarian value buyers that could step in the markets in periods of low liquidity and outbid the conservative bargain-hunting competition by strategically hedging market risk.

With secondaries pricing hovering around par, in particular for the vintage years of five or more years ago, the risk premium balance seems to be more in favor of the sellers. Secondaries investors beware when price and returns rely on leverage, and beta exposure is symmetric: the new secondaries order of things requires investors to understand their risk appetite more fully than ever before.