Three ways public markets are impacting secondaries

Secondaries deals are being disrupted by the fact that most of the world’s major public stock indices have fallen between 3 to 8 percent this year.

We wrote a few weeks ago that stock market fluctuations had derailed the purchase of a stake in a tail-end fund that was too exposed to public equities for the buyers’ comfort.

I’ve since had a number of conversations with other market participants who, while keen to note the secondaries industry overall is still vibrant and in no danger of decline, say day-to-day work is indeed being disrupted in various ways by the fact that most of the world’s major public stock indices have fallen between 3 to 8 percent this year.

Here are three examples:

1. The MAC is back

One partner at a secondaries firm told me he puts a material adverse change provision in his deals to protect himself from major changes that would make the fund interest less attractive. The so-called MAC clause he insists on is typically pegged to a specific index such as the S&P500 or a sub-index on energy for example, as long as it represents the portfolio, and is triggered when said index closes down by more than a certain percentage.

“They haven’t been so useful in recent years but one was just triggered recently as a result of the volatility,” he said. “We had a deal and a certain index closed down by more than 10 percent. I think it was almost 11 percent, so we walked away. It’s a binding offer but it gives me an out.”

2. Asian exit issues

One New York-based investor at a global firm was set to buy two Asian fund interests in the past month but retracted one of the two offers because a large company in the portfolio was too dependent on the stock market for an exit.

“We were about to invest in a China fund with a business that was going to go public through an IPO,” he said. “We walked away from it. It was too tied to the market. I could be under on day one.”

However, the other fund didn’t have such a close reliance on public equity markets and the investor went ahead and closed the transaction. “The other fund had more intrinsic value with more global and defensible assets,” he said.

3. Recalculating leverage

A lender to secondaries buyers said the recent volatility has prompted his firm to pay extra attention to how they value a transaction when calculating debt ratios.

“We lend versus the latest valuation available at the time we close,” he said, adding that it is the now-inflated June valuation. “But now we also make an adjustment based on public markets’ volatility because these valuations are not totally accurate.”

Contrary to those examples is what’s been going on with the world of real estate secondaries, which has been largely immune from public equity volatility. The real estate market continues to be robust and is not so correlated to public equities, keeping problems at bay. “We haven’t seen it really ripple through yet,” said one secondaries investor at a private real estate investment firm.

What have you experienced? Write to me at marine.c@peimedia.com.