The private equity secondaries market has experienced rapid growth in recent years, as institutional investors have taken an increasingly active approach to managing their portfolios. Secondaries are the only way for limited partners to exit early from their private equity investments — and the market’s growth is therefore a natural consequence of today’s large pool of outstanding private equity commitments.
In the decade to 2015, LPs committed approximately $3.9 trillion to private equity globally, according to Thomson Reuters. However, the onset of the global financial crisis after the Lehman Brothers crash led to tighter regulations and new economic realities, prompting many LPs to seek early exits from their commitments via the secondaries market. In consequence, the annual volume of secondaries transactions in 2014 and 2015, at around $40 billion, was two-and-a-half times its pre-crisis peak in 2007, according to Coller Capital. These annual secondaries transaction volumes represent 2.4 percent of private equity’s total net asset value.
Secondaries market transaction volumes, 1998-2016F
Average pricing for secondaries transactions (across all types of private equity assets) increased progressively from its post-crash low in 2009, stabilising in 2013 at around 90 percent of NAV, data from Greenhill Cogent show. This evolution reflects the growing maturity of the market and the increasing sophistication of its participants, on both the buy side and the sell side.
Stable pricing and numerous well-capitalised buyers, together with a large number of ageing private equity funds, have resulted in a very favourable environment for secondaries sales — and today the market feels both competitive and well balanced.
Within this environment, the motivations of investors looking to sell private equity assets can be divided into ‘strategic’ and ‘tactical’: strategic sellers (usually financial institutions) are looking to change their business or investment models in response to economic, regulatory or capital pressures; tactical sellers (typically pension funds, asset managers, endowments and foundations) are taking advantage of attractive pricing to reshape their portfolios.
The strategic pressures on financial institutions have been many and varied since the GFC: all banks have had to contend with Basel III; US banks with the Volcker Rule; and European insurance companies with Solvency II; not to mention the regulatory demands of the G20 Financial Stability Board. Banks in the Eurozone have been forced to shrink their balance sheets to compensate for sovereign debt write-downs, and publiclyowned banks in the UK and Ireland have faced government-imposed asset disposals.
Although strategic selling has slowed recently (it made up only 14 percent of secondaries transactions in 2015, according to Evercore), attention is now focusing on the US, where banks need to comply with the Volcker rule by July 2017. The value of private equity assets held on the balance sheets of major European and US banks, which are likely to engage in further strategic asset disposals in the medium term, is estimated by Coller at $50 billion. It is worth noting that this estimate does not include assets managed by banks for third parties.
Aggregate capital invested in private equity by investor type, 2011 and 2016
Tactical selling (or portfolio reshaping) continues apace as LPs use the secondaries market to modify the profile of their private equity portfolios by vintage year, by manager, by investment stage, by asset type, by fund concentration, or by geography. Many large investors are also disposing of private equity interests tactically, in order to focus more of their resources on a smaller core of high-quality managers. Portfolio reshaping also allows LPs to reduce the monitoring costs of their private equity holdings.
Liquidity solutions sought by GPs (rather than LPs) are becoming an increasingly important segment of the secondaries market. GP-led solutions are transactions in which a private equity manager works with a secondaries specialist to offer liquidity options to its existing investors, and to secure additional time and funding in order to maximise the value of its unrealised portfolio.
Lastly, it is worth noting that the volume of transactions involving real assets — infrastructure, natural resources and real estate — has increased significantly in recent years. Indeed, private equity real estate transactions accounted for 19 percent of overall secondaries market volume in 20156; CalPERS alone sold $3 billion of private equity real estate interests in the secondaries market in that year.