What are some of the biggest challenges in the secondaries market this year?
IC: We have gone a long time without a correction in US equities and real estate valuations. Whenever there’s a dramatic and rapid repricing of public equity or real estate valuations, it creates a large bid-ask spread in the secondaries market, and that causes volume to compress. That happened several times last year with the Chinese currency devaluation in Q1, Brexit in Q2 and the Trump election in Q4. A big shock to the system causes buyers and sellers to step back.
For the last 10 years, one-third of the capital Landmark has invested in private equity has gone into structured transactions, using dynamic waterfall or dynamic payment schemes that dampen and reduce the impact of valuation and duration shocks.
JS: Over the last several years, the majority of funds traded in the real estate secondaries market have been 2008-vintages or earlier. These funds have matured and many of these funds’ values have been marked up close to the anticipated liquidation value. Because of this, the discounts associated with many peak and pre-peak market vintages are increasing. Large optical discounts can create challenges for sellers who want to rebalance their portfolios, but who are discount-sensitive.
This challenge can be mitigated in a few ways. One is for the seller to include post-peak vintage funds that may price at lower discounts thereby reducing the overall portfolio’s optical discount. The other option is do something more structural. Real estate LPs are starting to become more comfortable with the structural solutions that we developed in the private equity secondaries market. This could mean a deferral transaction where you pay for the portfolio or fund over time, or buying a piece of a portfolio in a highly-structured transaction where there is a waterfall or cashflow sharing arrangement.
Where do you see the secondaries market heading for the remainder of 2017?
IC: Over the remaining four months of the year, if the macro environment stays accommodating, valuations continue to appreciate, liquidity stays at above-average levels, overall secondaries volume has the chance to break every record across every strategy. The high-water mark for secondaries volume, across all strategies, was the $42 billion to $44 billion that transacted in 2014. If the macro environment remains accommodating, $45 billion to $50 billion in total market volume is achievable. If public markets pull back more than 10 percent and the bid-ask spread widens, we’ll end up in the high $30 billions, which is still a strong volume year.
This article is sponsored by Landmark. It appears in the September issue of Private Equity International magazine.