How public volatility can kill a secondaries deal

Retail investors weren’t the only ones rethinking their moves in the midst of recent public market flux.

Retail investors weren’t the only ones rethinking their moves in the midst of recent public market flux.

Public market investors have had a wild ride the past couple weeks, with record losses and surges recorded around the globe.

The Shanghai Composite Index fell more than 15 percent between opening bell on Monday and closing on Tuesday, with analysts calling it ‘Black Monday’, but recovered and was down only 8 percent at close on Thursday. The S&P500 and the Dow Jones were both down about 8 percent between opening bell Monday and closing on Tuesday but had also recovered most of their losses as the end of Thursday.

In theory, private equity investors shouldn’t be affected much by these swings, given their long-term investment horizons. But in practice, sources say market volatility can cause some secondaries deals to fall apart.

“It can lead to a gap between sellers and buyers in terms of pricing,” a source told me.

This week, for instance, a New York-based buyer told me his firm was all set to purchase a fund stake when market turmoil intensified on Monday. The two parties had already agreed on price but the stock market plunge caused the buyer to rethink the transaction because the fund interest being sold had an exposure of about 40 percent to the public market.

“When buyers see volatility, they want to drop the price,” he said, adding that his firm ended up pulling out of the deal, no longer comfortable with the pricing considering market uncertainty.

This scenario won’t necessarily be an outlier, given so many 2006- and 2007-vintage funds hold older investments in companies that have gone public, but which they haven’t completely exited. Funds from these vintages may have as much as 30 to 50 percent of their NAV in publicly-held assets, sources estimate.

Similarly, some of the large real estate secondaries deals currently in play could be hit given public markets exposure, a US advisor noted. “People will probably be discounting public exposure for no other reason than the volatility,” he said.

Buyers may indeed require a bigger discount to NAV because they are currently buying based on June figures, likely to be higher than September NAV. Or they may simply want to wait until they see September valuations, which would slow down the pace.

It’s much harder to predict how volatile stock markets could impact the supply side. On the one hand, if sellers are concerned that a significant correction may happen, they may want to de-risk now and sell sooner rather than later.

On the other, because sellers, especially public pension plans, are typically against selling at a significant discount, they may want to wait until NAVs are adjusted downward, if they ever are, to minimise the size of a potential discount. As a result, it’s difficult to say whether volatility will impact transaction volume for the year.

But the secondaries market won’t grind to a halt solely based on a week’s worth of turmoil.

“While investors may slow down their investment pace, they certainly won’t halt it completely – especially considering the massive amount of dry powder held by secondaries firms, which is estimated to be between $70 billion and $90 billion,” a managing director at another advisory firm told me. “That being said, they could retrench in stages until volatility stops completely.”

Have this week’s market swings caused your firm to change tack in any way? Let me know at