Secondaries investors acquiring a preferred position in funds with a structured investment approach tend to decrease risk versus traditional secondaries investors, says a joint academic study released on Monday by PERACS and 17Capital.
A preferred equity fund’s senior position, resulting in priority on portfolio distributions and contractual returns, reduces the risk taken on each transaction.
The lower risk of preferred equity funds is typically combined with lower participation in the portfolio upside. As a result, limited partners selling to preferred equity buyers keep a greater share of their portfolio’s upside potential, according to the study. The research used a simulation of global buyout funds to assess the impact of acquisition structure on risk.
“The structured approach of preferred equity is a powerful tool, reducing the risk profile of the buyer by splitting up the cashflows between the buyer and seller,” said Oliver Gottschalg, an associate professor at HEC Paris and the founder of PERACS.
London-based 17Capital is a specialist preferred equity investor in private equity funds.
Deferral structures, where the buyer pays part of the purchase price upfront, represent another type of structured secondaries transaction. Market participants say this brings flexibility to buyers and sellers and is gaining popularity. Sellers tend to obtain a higher purchase price but don’t get the full price upfront.