Looking up

From a supply-side perspective, secondary market dynamics have never been so attractive, writes Landmark partner Ian Charles.

From a supply-side perspective, secondary market dynamics have never been so attractive, writes Landmark partner Ian Charles.

The global private equity secondary market continues to grow and evolve. Transaction activity was slow in the early part of 2013 but accelerated dramatically in the second half of the year. As a result, total market volume exceeded $25 billion for the first time in history. The dramatic increase in second-half deal volume was driven by active portfolio management needs, the return of large portfolio sales, regulatory pressure, fund restructurings and strong “nominal” secondary pricing. We expect many of these factors to continue this year and believe transaction volume could exceed $30 billion in 2014.

From a supply-side perspective, secondary market dynamics have never been this attractive. Globally, institutional investors own almost $2.4 trillion in private equity fund exposure. Over the last decade, the percentage of private equity value that trades in the secondary market has varied between 0.8 – 1.7 percent annually. As portfolio rebalancing, manager concentration and other active management strategies have become more common for investors, an annual turnover rate of at least one percent seems like a reasonable assumption over the next several years. Remarkably, Volcker and Basel-regulated global financial institutions still own more than $55 billion of private equity balance sheet exposure. Over the last two quarters, regulators have provided much needed clarity and many financial institutions have begun to develop portfolio liquidation strategies over the next 6-18 months. Fund restructurings and other innovative transaction structures are solving real issues in the market and unlocking new verticals of transaction volume for the coming years.

The demand-side of the secondary market is insufficient to meet near-term supply. We believe the available dry powder from existing secondary funds, as well as the capital expected to be raised over the next 18 months is approximately $50 billion. Including allowances for non-traditional buyer appetite and the use of modest leverage by some secondary buyers, total near-term buyer capacity is $60-65 billion, or the equivalent of the last 30 months of market activity. If the market continues to grow, the supply-demand dynamic favors buyers over the next several years. Another trend that should benefit buyers is a decline in market efficiency from sell-side advisors.

Since 2006, sell-side brokers have advised on 60-65 percent of total market volume and the service was dominated by two or three firms. However, sell-side advisors lost market share in 2013 and represented just over 50 percent of total market volume. Increasing competition from other successful providers and new market entrants has driven down advisory fees and made full-blown auction processes less compelling for secondary advisory firms. As a result, many advisors are modifying their services by providing “matchmaking” services between buyers and sellers, in exchange for more attractive buy-side compensation. We believe that over the next several years, two-thirds of the market volume will continue to involve an advisor, but a growing percentage of that volume will be less efficient processes that focus on speed, certainty and discretion rather than pure price maximization.

Regardless of near-term supply-demand dynamics, the most significant factor in 2014 market volume is the global equity markets. If equities maintain modest growth throughout the year, the lagged and smoothed nature of private equity valuations will provide “nominal” secondary pricing optics that sellers desire while also providing attractive “real” pricing that secondary buyers are seeking. Without robust market growth, “nominal” and “real” pricing will soften, the bid-ask spread will widen and market volume will fall, much like the summer of 2011. However, if the economy continues to stabilize and equity markets grow, the secondary market should continue to reach record transaction levels.


Ian Charles is a partner at Landmark Partners, responsible for sourcing private equity and real estate secondary transactions, developing new structural solutions for institutional investors and negotiating private equity investments.