As exit options narrow, search for liquidity will drive secondaries volume

Recently released first-half secondaries deal volume surveys show that, despite uncertainty and volatility in the broader economy, secondaries activity remains robust.

GPs increasingly are looking for ways to provide liquidity to investors in older funds when there is an absence of robust options to exit investments.

And LPs, contending with overweight exposure to private equity, as well as seeking capital to continue committing to new funds, are also on the search for liquidity options.

Both these factors will help drive secondaries deal flow in the second half of the year, as the dynamics may have changed, but the result will be the same: hefty transaction volume helping keep the market busy despite uncertainty.

“We’re seeing a desire for liquidity that is not being met by the natural driver of liquidity in private equity, which are the M&A and IPO markets,” said Holcombe Green, global head of private capital advisory at Lazard. “When exit markets contract, clients look for other routes to liquidity and [secondaries] are one of those.”

“It’s a function of LPs being relatively short of capital,” explained Nigel Dawn, head of private capital advisory at Evercore.

Lazard and Evercore recently released first-half secondaries deal volume surveys showing that, despite uncertainty and volatility in the broader economy, secondaries activity remains robust. Lazard estimated total deal volume around $59 billion, beating last year’s first-half total of $48 billion (though coming in well under the record $126 billion during the same period in 2020).

Evercore estimated total deal volume at about $53 billion, an 11 percent jump from the $48 billion at the same time last year.

LP portfolio sales, which Lazard estimated at around $32 billion, helped drive volume. Evercore estimated LPs sales at $26 billion, compared with $27 billion in GP-led deals.

LP sales, which slowed in 2020 amid a crush of GP-led deals, especially single-asset transactions, came back strong in the second half of 2021. Such sales will likely help to continue driving secondaries activity going forward as LPs seek ways to monetize their PE stakes, Green said.

“There’s been a bit of a swing back to LP deals, and a bit risk-off on single-asset deals,” Dawn said. Evercore estimates single-asset deals represented about 51 percent of GP-led transactions in the first half, up from 47 percent during the same period last year. However, investors in aggregate deployed smaller equity slugs in single asset deals versus their maximum potential equity investment and concentration limits, Evercore found.

LPs’ desire for liquidity has also led to more investors selling into GP-led continuation fund processes, Lazard found. While GP-led volume is down from last year, the selling volume in such deals is up, the survey said.

Several public pensions have become overweight in their private equity holdings, meaning they are at or above their policy exposure caps. This occurs when public stock holdings decline, bringing down a fund’s total assets, while private equity holdings remain steady because of strong performance, or because performance marks lag public markets by a quarter or more.

This year, GPs have generally kept their portfolio company valuation marks flat, or even slightly up, in the first quarter. Second-quarter marks are being published now, and sources have said they believe they’ll remain flat, rather than reflect the pain in the wider economy. In this case, LP portfolios will remain out of balance unless public markets stage a strong reversal.

“We’re anticipating significant issuance by GPs and LPs against a second-quarter record date with lots of deals that get done in the fourth quarter and the first quarter of next year,” Green said. “Pricing will strengthen going to the end of the year.”

Pricing remains one of the stumbling blocks on both the GP-led and the LP sales sides of the business. Deals are now being priced off reference dates of March 31 or even June 30, but those dates aren’t reflective of the turmoil that’s been rocking the broader economy. Because of this, buyers are demanding discounts to net asset value as of those dates, which causes some sellers to back away, and some potential GP-led processes to delay hitting the market.

“It’s still a little challenging for LPs to sell without taking a discount, but sentiment is the market is definitely improving,” Dawn said. “And the size of the discount depends on what’s being sold.”

Pricing discrepancies, as well as a lack of capital from buyers who are out fundraising, has led to a slowdown in more recent deal volume, sources have told Buyouts. In part, this is also reflective of secondaries buyers becoming pickier in which deals they pursue, Green said.

“The secondary investor community is more selective about what they’ll spend time on, what they’ll do and more skeptical about business plans and economic resilience in business models. That is causing the deals that are a little more complicated to be a little more complex to execute,” Green said.

Update: This report was updated with quotes from Nigel Dawn.