As capital calls outpace distributions, LP secondaries take center stage: Jefferies

Limited partners offered more, and sold less, than expected in secondaries deals last year, even as LP portfolio sales eclipsed GP-led processes like single asset continuation funds for the first time since 2019, according to fresh research from Jefferies.

Total secondaries volume, at about $108 billion, was down last year compared with 2021’s massive $132 billion haul, Jefferies said in its full-year 2022 volume report. Even with the slowdown, 2022 remained the second busiest year on record for the niche strategy. Volume likely would have gotten close to 2021’s record if not for a continual decline in prices as the year progressed, which caused activity to slow in the second half.

However, many market professionals, including Jefferies, anticipate 2023 will be a record year as pent-up demand bursts through pricing hesitation and stored-up dry powder is unleashed.

Market dynamics helped push LP portfolio sales to center stage, with about $56 billion of volume, as many institutions dealt with overexposure to the asset class. LPs also contended with dwindling distributions that resulted from slowing exit activity on the part of GPs.

“Most LP sellers sought to rebalance their portfolios given overallocation to private equity, and approximately 50 percent of all LP sellers were first-time sellers,” Jefferies said in its report. “A widening bid/ask spread kept many potential sellers on the sidelines.”

Because of this, secondaries professionals anticipate a busy year this year, with those who waited out the pricing declines in 2022 expected to come back with their offerings once the market finds its floor.

“Capital calls are now outpacing distributions for LPs. That’s the first time that’s happened in several years. We think that’s going to continue for a while,” said Todd Miller, global co-head of private capital advisory at Jefferies. “That will put pressure on LPs to do more sales, and supply will build. We expect is to be a very active year.”

Average pricing for LP sales was 81 percent of net asset value, an 1,100 basis point decline from 2021, Jefferies said. Pricing discrepancies caused LPs to hold back portfolios, or sometimes only sell portions of their full offering.

Many selling LPs brought larger portfolios than they intended to “increase optionality,” Jefferies said. They often ended up selling less than 50 percent of their desired amount because of soft pricing, the report said.

“Still, we estimate that less than 5 percent of LP deals were completely shelved in 2022, as sellers valued liquidity over hitting a certain ‘reserve’ price in most cases,” the report said.

GP-led deals like single and multi-asset continuation funds came in around $52 billion, a 24 percent decline from the prior year, Jefferies found. GP-led deals faced the challenge of making it to closing as many such processes struggled to successfully syndicate out to groups of investors.

GPs put more of their own money at risk in deals last year. About 90 percent of closed GP-led deals included key principals at the GP re-investing 100 percent of their realized proceeds back into the deal, Jefferies said. A minority of such deals included sponsors committing capital beyond their roll-over of realized proceeds, the report said.

Also, about 25 percent of closed single-asset deals featured cross-fund aspects, with the GP kicking in capital from its new fund, the report said.

In today’s market environment, cross-fund commitments in single-company GP-led deals are becoming a more common part of such transactions, according to Matt Wesley, global head of private capital advisory at Jefferies. “I expect that number to approach 50 percent this year,” Wesley said.

Cross-fund investments along side continuation funds may increase in part because GPs will be looking for ways to deploy capital even as financing remains hard to come by for new investments, Wesley said.