LPs Have Big Interest In Buying Secondary Interests

Institutional investors have a high level of interest in buying partnership interests on the secondary market, but their expectation that interests will trade at steep discounts suggests they may just be searching for bargains, according to the results of a recent survey.

The survey of 250 institutional investors worldwide found that nearly 80 percent of respondents either have already bought an LP stake or expect to do so. Nearly half of the respondents (46 percent) said they have bought interests from “multiple sources.” The survey, conducted by placement agent and secondary advisory shop Almeida Capital, London, in association with private equity research firm AltAssets, London, also reveals a strong appetite among investors for backing secondary funds. More than 60 percent of those surveyed have invested in a secondary fund or seek to.

The main motivation for those purchasing secondary transactions has been to improve returns (92 percent picked this as a reason) and to reduce the effect of the j-curve (80 percent). Respondents to the survey were able to pick more than one answer.

At the same time, investors expect limited partnership interests to trade at substantial discounts, according to the survey. For interests in large, vintage-2005 buyout funds, for example, respondents expect to see average discounts in the 40 percent to 50 percent range; for large, vintage-2006 and vintage-2007 buyout funds, respondents expect to see 60 percent to 70 percent discounts. Such expectations suggest that many investors may only pull the trigger if they feel they’re getting a real bargain.

Richard Sachar, managing director of Almeida Capital, said his firm has seen and advised on a number of relatively small deals involving high calibre funds being sold to investors at sensible prices. According to Sachar: “Discerning secondary investors are prepared to pay realistic prices for the funds they want and to build or enhance their relationships with top-quality managers. But they shy away from deals where they are pressured to bid for low-grade funds at the same time as part of a portfolio sale.”

As for the sell-side, nearly half of the respondents to the survey have sold or plan to sell a secondary interest. The main motivation for sellers: the poor performance of funds (44 percent of fund-of-funds surveyed, and 58 percent of other LPs surveyed cited this as a reason). That was followed by the reallocation of cash to better performing funds (33 percent of fund-of-funds and 57 percent of other LPs). A change in investment strategy; reduction in the number of GP relationships; short or medium term requirements for cash and a need to reduce private equity exposure were less popular factors for selling.

Active sellers at the moment include family offices, distressed banks and listed Switzerland-based fund-of-funds such as shaPE Capital AG, an investment company founded in 2001 and managed by Horizon21 Private Equity. ShaPE successfully completed the sale of 15 partnership interests on 30 June 2009, according to the company’s half-year report. AIG Private Equity, a fund of funds listed on the Swiss stock exchange, has also recently sold complete or partial interests in funds that include Advent International VI, Ares III, Apollo VII, Affinity Asia Pacific Fund III, Carlyle V, Charlesbank Equity Partners VI, FountainVest China Growth Capital Fund, Mid Europa III, Olympus Growth V, Sovereign Capital II, Terra Firma Investments III and Towerbrook Capital Partners III.