Portfolio management drives the secondary market

AIG Global Investment became the latest large-scale purchaser of private equity assets in the secondary market with the acquisition of LP interests worth €1.1bn from Dresdner Bank’s Institutional Restructuring unit. The sale involves 150 funds, with one-third of the assets sitting in Europe and Asia.

The sale extends AIG’s global private equity business, which has US$15bn in assets under management, according to David Pinkerton, head of alternative investments at AIG Global. “It will provide AIGGIG with an expanded window on both new fund and continuing co-investment opportunities,” he said.

For Dresdner, the transaction affords a final exit from private equity. It is the latest in a series of banks that have sold private equity assets in order to sever links with what has traditionally been seen as a volatile asset class.

Deutsche Bank recently unravelled its exposure to private equity with the sale of 21 LP interests worth US$382m to Axa Private Equity’s early fund of funds. CIBC has also pared down its exposure. Dresdner will not be the last seller using the secondary market in this manner. Generally speaking, however, motivations for secondary sales are likely to be more complex and diverse in future.

Until recently, the private equity secondary market was a cottage industry used in response to external factors such as over-allocation, changes in ownership or changes in management. Currently, deal-flow is increasing rapidly and secondary transactions are being used pro-actively to manage portfolios.

“We have worked through most of the distressed selling of the post-venture bubble,” said Marleen Groen, chief executive of London-based secondary specialist Greenpark Capital. “Now we are back to a situation where sales are happening for any of the more stable reasons, most notably portfolio management.”

The global secondaries market dates back to the late 1970s, when Dayton Carr, the founder of Venture Capital Fund of America, completed the first transfer of a venture capital fund position. By way of comparison, between US$6bn and US$8bn of private equity assets changed hands last year, according to estimates from Greenpark. Between 1% and 3% of the private equity capital pool is recycled into secondaries each year.

As liquidity has increased, so too has the size of the deals. AlpInvest and Lexington Partners recently closed one of the largest-ever secondary purchases of a private equity portfolio. The firms bought interests in 46 funds managed by 27 private equity firms in a US$1.2bn deal with corporate seller DPL.

Funded and unfunded commitments managed by GPs including KKR and CVC Europe were included in the DPL sale. This adds weight to the perception that secondary sales have lost the earlier sense of stigma attached to them by some GPs.

“GPs now recognise the advantages of dealing with secondary players and are aware of the benefits that we bring to the asset class as investors,” said Tim Jones, a London-based partner at global secondaries firm Coller Capital.

“We help to provide a liquidity solution to what has traditionally been a long-term and illiquid market. GPs recognise that LPs often have perfectly valid reasons for exiting funds and secondary investors enable them to achieve this. It has now become prestigious to have a strong secondary investor entering your fund.”

The move away from an illiquid cottage industry started to gather pace in the mid to late-1990s. Coller made headlines in 1998, when it bought a private equity portfolio from Shell Pension Trust for US$265m. At the time, the transaction was the largest single sale of a private equity portfolio by a pension fund.

A couple of years later, Coller became the majority investor in three portfolios that were auctioned off by NatWest as part of its defence against the takeover by RBS. That transaction, worth more than US$1bn, exemplified how much the market had grown and how much more transparent the larger deals had become.

So, where is the deal-flow likely to come from in future? Secondary professionals agree that most banks have worked through their allocation issues, although there is more of an overhang for the insurance companies. Many predict that corporates will be the most active sellers, perhaps sparking more deals to rival DPL.

And the buyers? Coller Capital still has the distinction of owning the world’s largest private equity secondaries fund. The US$2.6bn vehicle is almost fully invested, but the firm flatly denies reports that it will be looking to raise a US$5bn fund when it returns to market.

There are a handful of other secondary investors due to hit the fundraising trail soon. These include Lexington, which is likely to start out with a US$2bn target, but which can expect to raise over US$3bn at least.

The main constraints for the market are the expectations of the sellers themselves and the still largely non-transparent nature of the asset class. Sellers expect full prices for portfolios, and most assets are contested by at least two or three potential buyers.