More European investors are ploughing money into secondaries funds and are encouraged by a steady stream of local secondaries investment activity.
Seen for so long as a niche strategy centred on the large US private equity market, investors’ views are changing. Big deals brought by European sellers are giving European limited partners a reason to invest more time and capital in the secondaries market. That in turn is providing a useful fillip to secondaries fundraising.
“Historically, our LPs have been more US-based. But if I look at the appetite among European LPs for the last fund, we have new LPs investing and the existing ones tended to re-up with a larger amounts,” said Olivier Decannière, head of Ardian UK. “I don’t see appetite getting any weaker.”
Ardian raised $9 billion for its latest secondaries fund last April, eclipsing its previous effort by almost $2 billion. It cemented its reputation with a string of large deals in the US in the early post-crisis years, notably its $1.7 billion portfolio purchase from Citigroup in 2011, as banks purged assets to clean up their balance sheets.
European deleveraging was slower to start, and arguably has much further to run – 25 banks out of 123 failed European Central Bank stress tests in October last year, with Italy faring the worst. The following month Ardian bought a portfolio of fund investments and co-investments from an Italian financial institution for $696 million. A coincidence perhaps, but secondaries funds expect the run of activity to continue.
“There has been transfer of activity over to Europe. There was a big glut of deal flow in the early post-crisis period in the US. Since then European investors have seen that repeated here,” said Nik Morandi, a partner at private equity fund manager Pantheon.
Still, high levels of capital, high seller price expectations and high levels of leverage are creating a heady mix which is driving up prices. The average discount on the secondary market was 6 percent for the six months through January, with large US buyout funds trading at a premium of 1 percent on average, according to data from secondaries advisor Triago. The quality of assets sold may be better than immediately after the crisis, but some investors here are worried.
“It is a concern. Are we at the top of the market right now and are we overpaying for assets?” said Ian Shanks, senior investment manager at Aberdeen Asset Management.
Not only are deals going through at much closer to net asset value, but those valuations have also increased over the last 18 months. They have been buoyed by a bull run in stock markets, itself fuelled by mountains of liquidity pumped in by central banks. New quantitative easing from the European Central Bank should make European exports more competitive and keep inflating financial markets, preventing a hard landing in the short term.
But investors are understandably twitchy about the prospect of a Greek exit from the euro zone, and the damage that could inflict on the rest of the continent. European investors take a more sanguine view on alarmist European headlines than their overseas counterparts, but secondaries funds are succeeding in shoring up confidence with their business-as-usual approach. “Buyers are doing a fine job convincing people it’s still a good place to invest,” Triago managing partner Mathieu Dréan said.
However, what is less clear is where secondaries funds meet with their investors on expected returns. Dréan thinks that most LPs now accept a return of 1.4x their money and annualised performance in the low teens. Ardian’s Decannière thinks well-chosen managers should deliver above 1.5x. Meanwhile, Aberdeen’s Shanks believes that a return of 1.6x on average (and up to 1.8x), producing an internal rate of return of 20 percent, should be achievable.
Still with fierce competition for assets, high prices and European volatility weighing on the sector, the highest expectations are likely to come under pressure. “Where I think the risk might go is that the money multiple band will get tighter and come down,” Shanks said. “Does it come down to 1.3x to 1.5x?”
Reporting by Simon Meads