The LP secondaries market – the trading of second-hand stakes in limited partnerships – was worth around $57 billion last year, according to data from investment bank Greenhill. It’s an area that has more than doubled in value in the space of a decade.
Could this growing market of second-hand fund stakes act as a proxy for valuing a given GP’s portfolio in the same way current share prices are used in public markets to value listed companies by their market capitalisation?
It’s a compelling thought exercise, one that affiliate title Private Equity International has put to various market participants.
At the heart of the thesis is this: fund sponsors do not value their portfolios on a daily basis in the same way that the stock market – itself a secondary market – provides a live market price for a given listed company. Yet when LPs trade in and out of a private equity fund, they trade at a price that is typically relative to the fund’s latest NAV – at par, a premium or a discount. Could existing trades such as these be used to give a more accurate valuation of the assets held in a given GP’s fund?
Take Blackstone’s 2011-vintage Blackstone Capital Partners VI fund, for which second-hand stakes traded at a 9 percent discount to NAV in the six months to Q3 2022, according to data compiled by Palico. Does this imply that Blackstone should mark its assets held in BCP VI down because the market believes it is worth 9 percent less than its latest valuation? Similarly, should Apax Partners – which had successful trades of a 7 percent premium to NAV in its 2016-vintage Apax IX fund over the same time period – mark its fund’s portfolio up by 7 percent?
“The secondary market is a proxy for preferences; it’s not a valuation proxy,” says Adrian Millan, partner at advisory firm PJT Park Hill.
He notes that there are at least two main reasons why secondaries market trades in private funds cannot act in the same way public markets do when valuing listed companies: first, there still isn’t enough trading volume for any meaningful observations to be drawn. While some popular funds may be subject to multiple trades per year, other funds may not be subject to trades at all. Second, the way a buyer approaches underwriting the assets in a fund when purchasing an LP interest is nuanced around a certain point in time and the specifics of the situation, such as whether the seller is in distress and looking for a quick sale.
“You have so many disparate factors that it’s tough to draw the analogy [with public markets],” Millan says.
Dushy Sivanithy, managing director and head of secondaries at CPP Investments, says that buyers of second-hand fund stakes will price in many factors to a bid beyond what they simply think the underlying companies are worth. This consideration comes in addition to the fact they are often buying and holding a passive, minority position.
Such factors include macroeconomic conditions, exit prospects, trading volatility, GP alignment, manager track record, return requirements, risk tolerance, diversification and portfolio construction, he says.
Further complicating the issue is the delayed nature of the valuation date upon which second-hand fund stakes are typically traded. Most trades are based on a valuation date which is, at best, 45 days old and, at worst, several months old. In the time since the latest valuation, the exit environment could have changed significantly.
Ted Craig, a partner at law firm Paul Hastings, points out that most LPs commit to funds and hold onto their fund stakes. To these LPs, a GP’s fund valuation doesn’t act as a pricing tool for them to know when might be a good time for them to sell out of the fund – rather, it is an indication of how the portfolio is performing.
“It’s an overview of what LP money has been spent on,” Craig says. “A GP isn’t of course guaranteeing it is going to sell any of these companies for any of these numbers – not least because it’s going to hold them for another, say, five years or so.”
What secondaries market pricing is actually indicative of is a particular viewpoint on the ability of a GP to exit its assets within a specific time period, as well as the exit potential of those assets.
Secondaries transactions and discounts are a proxy for the quality of GPs and their investment portfolios on a relative basis, according to Millan. A fund stake trading at a discount to NAV is a barometer of how much of a haircut a secondaries buyer would need when underwriting the trade in order to get from the fund’s latest valuation to a current NPV of the fair market value of those assets’ exit, he adds.
“The secondary market is taking a view on the duration to exit and the quantum of uplift,” Millan says. The valuation – the current NAV – reflects what the GP believes it could receive for an asset if it sold it today in a strategic sale or other exit path, he adds. “They’re two separate events.”