LPs turn opportunistic, sell younger-vintage funds on secondary market

  • First-half secondary volume breaks records at $22 bln
  • Dry powder remains high for secondary deals
  • LPs eye younger funds to sweeten portfolios

More limited partners are selling portfolios that include young funds — those raised within the past five years — as they become more opportunistic in actively managing their private equity portfolios, according to Greenhill Cogent’s half-year volume report.

Generally, portfolios of traditional LP interests are composed of older funds, including stakes in pools 10 years or older. But LPs are more willing to sell out of a fund from a manager to whom the LP will not commit in the future, Greenhill Cogent said.

LP organizations also turn over frequently, and new investment officers are willing to sell out of positions in portfolios built by other people if they don’t match their vision, even if those relationships are only a few years old. Including some younger funds in a portfolio of older vintages can sweeten the price, since younger funds have more upside than older funds that have been mostly or fully invested.

Monetizing non-core positions

“All types of institutional investors are being opportunistic on the sell side right now. … They’re taking the opportunity to monetize things that are non-core,” Brian Mooney, a managing director and co-founder of Greenhill Cogent, said in a prior interview.

This is markedly different than in the past when an LP would hold an interest through the life of the fund unless motivated to sell for some compelling reason.

“More frequently than ever, we are seeing new teams utilize the secondary market to reposition the private portfolio within their first year or two on the job,” according to Cogent’s report. “Selling more recent vintage funds that may not be consistent with the repositioned portfolio, and that have a higher proportion of unfunded exposure, is helpful to LPs seeking to achieve this portfolio shift more quickly.”

Around 10 percent of the buyout funds sold in market in the first half by number, and 14 percent by net asset value, were in funds raised in the past five years, Greenhill Cogent said. That compares with only 7 percent of NAV in younger funds in 2016.

Among portfolios Greenhill Cogent sold in the first half, more than 60 percent included at least one fund raised in the past five years, and roughly one-quarter included at least one fund raised in the past three years.

This is more evidence that the secondary market has become a tool that LPs routinely use to actively manage their alternative-investment holdings. Such a quick flip of an interest in a young fund shows that LPs don’t hesitate to be opportunistic when they decide to not pursue a further relationship with a GP.

This activity contributed to record secondary volume, which Greenhill Cogent estimated at $22 billion in the first half. This included five deals of $1 billion or more, another marked difference from 2016 when $1 billion-plus portfolios were rare.

Interestingly, the hottest aspect of the secondary market in the past few years, GP-led processes like restructurings and tender offers, trailed off in the first half. Greenhill Cogent estimates GP-led deals represented less than 15 percent of market volume in the period.

‘Transition period’

“We believe we are in a transition period where the types of GP-led deals are shifting from fund restructurings toward a greater focus on more LP-friendly tender-style processes,” Greenhill Cogent said. “With several sizable GP-led processes in the market, we expect that [the] second half will see a much larger share of GP-led volume.”

Pricing remains high, especially for brand-name funds. The average high bid for all funds was 91 percent of NAV in the first half, a 200-basis-point increase from 2016 pricing, Greenhill Cogent said. Buyout funds represent the highest pricing, at 98 percent of NAV.

Secondary GPs have to transact even with pricings so high because the secondary market has also seen record fundraising. Greenhill Cogent found about $74 billion of unspent capital available to buy secondaries interests at the end of 2016. As of June, Greenhill Cogent found that number to have dropped to $68 billion — though secondary buyers are aiming to raise another $16 billion.

One secondary buyer said that because of the high prices and the large amount of dry powder in the market, returns for recent vintages are likely to fall.

Action Item: Read more about Greenhill Cogent here: http://bit.ly/2tUlC3K

An Austin car is seen at a flea market boot fair in Lymington, Britain, on June 25. 2017. Photo courtesy Reuters/Kevin Coombs