Of tail-ends and dogs

Sales of tail-end fund stakes are expected to increase this year, so buyers will have to carefully weigh the enticing discounts against some potential portfolio howlers.

If recent market reports are anything to go by, 2016 will be the year of tail-end sales.

The definition of tail-ends differs. NYPPEX Private Markets defines them as funds with less than 30 percent of unrealised value versus capital commitments, or being greater than nine years old. Another source I spoke to defined tail-ends as situations where investors are in need of liquidity, the general partner needs more time for value creation, and the buyer typically acquires all remaining stakes in the fund.

What the market agrees on, however, is that tail-ends will increase as a proportion of the overall secondaries market this year, and therefore pricing will drop to present some particularly attractive discounts.

NYPPEX predicts sales of tail-end stakes will rise to account for almost half of total secondaries deal volume this year. Meanwhile, estimates put the amount of unrealised value in funds raised prior to 2006 at around $184 billion.

This means firms specialising in tail-end acquisitions such as Headway Capital Partners and Hollyport Capital, both London firms, likely won’t have problems with dealflow. The issue firms that buy tail-end positions have, I’m told, is sorting the quality assets from the junk, and this takes resources and time.

“You’re going to see people throw in a lot of dogs this year,” a lawyer who advises clients on tail-end solutions said, referring to sellers’ attempts to get rid of less attractive assets.

“You’re buying into funds that may be 14 years old and have companies that have missed their original business plans,” added a source at a firm that buys tail-end stakes . “Why did they do that? Are they not good assets? Are you left with a bunch of underperforming businesses? That is the fundamental challenge.”

Tail-end dealflow often comes from sellers wanting to wind up mature positions for administrative purposes, and buyers of these stakes benefit from either acquiring positions at a discount, or if the acquired assets are later sold at a premium, or both.

It can be difficult, however, to find exits for assets left in tail-end funds because by their nature, mature funds hold the portfolio companies that are most difficult to sell, and it requires expertise to make these work.

Other challenges include navigating concentration risks, where one asset accounts for the majority of the remaining NAV, and working out the GP’s intentions and priorities.

“You can find some interesting gems in those older portfolios that haven’t matured,” Sebastian Junoy, a partner at Headway told me. “That’s part of the challenge: when are they going to generate liquidity, can they generate above average returns from where the GP marks them at?”

The year has already got off to a flying start with tail-end portfolio sales such as Partners Group’s €450 million purchase of real estate fund stakes from Sveafastigheter and Ardian’s acquisition of a European buyout portfolio from Bregal.

And with two-thirds of LPs telling a survey by Credit Suisse that they have no formal process for dealing with tail-end issues, buyers with the expertise to source and evaluate such deals are spoilt for choice this year.

The challenge? Not getting bitten by the dogs.

How do you get the balance right in tail-end funds? Get in touch at adam.l@peimedia.com