Net IRR outperforms for secondaries

Secondary funds outperform direct funds in terms of net IRR, according to Capital Dynamics.

Secondaries funds with vintages between 1993 and 2009 have recorded average net internal rates of return of 17 percent, comfortably beating the average of 12.3 percent seen for primary funds from the same vintage years, according to a white paper on private equity secondaries from Swiss asset manager Capital Dynamics.

After comparing data for all available funds, Capital Dynamics said that the net IRR outperformance of secondaries was mainly due to the funds’ inherent discounts and shorter holding periods.

Source: Cambridge Associates and Capital Dynamics

Secondaries funds from 1993- to 2009-vintages did less well in terms of net multiples however. Analysis of the same data set showed an average net multiple of 1.55x for secondaries funds, compared to 1.67x for primary funds.

The higher net IRR figure was also a result of savings in management fees, according to Sandro Galfetti, a director on Capital Dynamics’ secondaries team. Investments in poor-performing companies may have already been written off earlier in a fund’s life.

“With secondaries, you know what you are buying,” Galfetti said. “You don’t have the blind pool risk. So when you come later to the game, ultimate IRR of the investment tends to be higher.”

Although secondary investors may also miss out on two or three distributions on successful companies that may have already been made, which could explain the lower net multiple, Galfetti added.

A number of factors such as the use of leverage, could affect a fund’s net IRR in the future, however.

“IRRs for secondaries may be coming down slightly these days as people are more aggressively underwriting purchases. Then again some of the funds apply leverage, which could boost IRRs back up again,” he said.

Still the IRR of secondaries funds is expected to continue to outperform the net IRR of primary funds by about 5 percent, Galfetti said.