There’s a question Secondaries Investor likes to ask market participants at the end of interviews or at industry conferences: is private equity now a liquid asset class and does it need to be? Research published this week by Upwelling Capital Group suggests this is now a more important question than ever.
According to the report, limited partners holding 10-year-plus fund positions who expect the remaining value to be returned should considering selling, even at a double-digit discount, and redeploying the capital. Upwelling looked at 1,496 US funds of vintages between 1998 and 2011 to draw its conclusion.
The research throws a curve ball at conventional wisdom that private equity funds will continue to deliver value past year 10 and that investors are better off sitting back and waiting for remaining value to be returned, Upwelling founder Joncarlo Mark tells us. LPs who don’t proactively manage their private equity commitments by selling on the secondaries market could be incurring huge opportunity costs.
It’s important to note that Upwelling is an advisory and investment management firm that would benefit from advising LPs on selling tail-end positions.
Nevertheless, the research is compelling: total value to paid-in multiples fell from year 11 across first quartile and fourth quartile funds, with the mean of quartiles also falling. In fact, the opportunity cost of holding a top quartile fund is higher than holding any other quartile-ranked funds.
The thinking is: if you continue to have access to top quartile managers and you’re holding something with no growth, you could be redeploying capital into those high performing GPs. Upwelling compared years zero to 10 with years 11 to 20 and calculated that on the remaining capital in a tail-end fund, if an investor was able to redeploy that capital into a top quartile fund, the difference in performance is 90 percent better in the new top quartile fund versus the expected performance in the 20-year-old tail-end fund.
With an estimated half a trillion dollars worth of unrealised value held in tail-end funds, the potential dealflow for secondaries buyers is enormous, to put it lightly.
Buyers such as Strategic Partners, Ardian and Schroder Adveq are already active in this area, with some of them raising dedicated funds for buying mature stakes. Hollyport Capital has been specialising in buying tail-end stakes since 2006 and if its rapid growth is anything to go by (the firm’s debut fund was a mere £6 million ($8 million; €7 million); its latest iteration is seeking $750 million), there’s a buck to be made in this corner of the market.
Upwelling notes its research could be refined. A dataset that tracks a constant sample of funds would improve its model by removing survivor bias, and its reinvestment assumptions could be made according to a draw-down schedule rather than immediate deployment, to better reflect LPs’ realities, it notes. Still, the research should make LPs sit up and rethink their mature fund commitments.