No big deal

A second dip in annual deal volume isn’t cause for alarm if practitioners position themselves properly.

It’s around this time that end of year reports start trickling into our inboxes at Secondaries Investor, and they all seem to bear the same message: deal volume for 2016 will be down on 2015.

The market “took a breath” last year, Lazard wrote in its end of year review, while advisory firm and placement agent Triago – the only firm to put a number on it so far – estimated $39 billion in trades closed last year, a slight dip from 2015’s $40 billion.

So is the drop something to worry about? Well, that depends on where you sit in the market.

If you’re a large buyer with a $5 billion fund or more to invest, a lack of big deals can mean you simply move into smaller deals or look for more innovative non-traditional transactions. There are a handful of buyers in this category – Ardian, Lexington Partners, Strategic Partners, Coller Capital, Goldman Sachs – and competition among them remains fierce. For example, when Florida’s State Board of Administration brought a $1 billion portfolio of private equity and venture capital stakes to market in November it was swiftly snapped up by a large buyer who pre-empted other bids.

Smaller buyers I spoke to were less concerned about overall deal volume, although a partner at one Zurich-based firm told me he had started to see big buyers appear in smaller-sized auctions – a sign of deployment pressure’s trickledown effect.

I asked a New York-based managing director at a global investment firm whether he was worried about the fall. “Of course I think about it, but I don’t necessarily worry, because we’ve had such a strong last six to seven years in the market that this is a bit of a short-term blip, rather than the new norm,” he said. The rate at which primary private equity funds turn over on the secondaries market is 2 percent to 3 percent per annum, which could grow to the high single digits within a few years, he added.

And as Jeff Akers, head of secondaries at Adams Street Partners, put it to me: “Our secondary investment activity is rarely correlated with overall secondary market volume.”

While a rising  volume of closable dealflow is generally well received by those in the market, a slight overall drop doesn’t mean some segments aren’t booming. Take infrastructure, which hit a record high of $4.5 billion in trades last year, according to Lazard, or GP-led deals, which increased to 30 percent from 20 percent of the market. This would put the GP-led market at anywhere between $10.5 billion and $11.7 billion, depending on which estimate you use.

It also matters how young a secondaries fund is. Secondaries are sold as a way to beat the J-curve, but for this to happen the fund needs to start deploying capital early in its life. And with $30.7 billion raised for the strategy last year, that pressure is more acute for managers who’ve just closed their funds than those who are 50 percent invested, one source pointed out.

A drop in deal volume while dry powder is piling up – to $105 billion, Lazard estimates – could mean firms are raising funds that are too large for the market opportunity. If so, expect to see more in the way of innovative, non-traditional transactions.

How will your firm address the drop in volume? Let me know your thoughts: adam.l@peimedia.com or @adamtuyenle