Secondary interests, primary concern

The secondaries market has become an established part of the private equity landscape according to research compiled by UK headquartered private equity consultants and placement agents Almeida Capital.

For years secondaries have been treated with suspicion and remained very much a niche part of the market, but over the last two years, as the industry has grown, so has the trend for LPs to sell their positions in funds and for other LPs to buy them. An overwhelming majority (83%) of the 100 investors surveyed by Almeida for Limited Partner Activity in Private Equity Secondaries, revealed they have either bought a direct secondary interest in a fund or portfolio of companies (65%) or intend to buy a direct secondary interest (18%).

Richard Sachar, managing director of Almeida Capital, said: “Our latest survey has confirmed what we as an active player in the secondary market have experienced over the past two years: LPs are increasingly keen to buy and sell secondary interests and have created a dynamic, rapidly growing secondary private equity market. The most sophisticated investors are using secondary trading as an effective portfolio management tool.”

Investors do not appear do favour one source of secondary interests over another, with over half of respondents buying from multiple sources, and 36% just from another LP. The results also show that LPs’ appetite for direct secondaries is strong regardless of whether they have invested in a secondary fund before. The proportion of LPs that have acquired or expect to acquire direct secondaries after already investing in secondary funds (84%) is roughly the same proportion as those LPs that have not invested in such funds (81%).

On the sale side, 33% of respondents have sold a secondary, with auctions representing 41% of those sales, with 25% going to other LPs, and with 22% of all LPs surveyed who have not sold, planning to do so. Eighty-nine percent of secondary buyers want positions in buyout funds, but the 66% recorded for positions in venture funds is surprisingly high, higher, says the report, that each respective LP’s appetite for primary venture funds. Buyers also have a strong appetite for portfolios of companies (41%) and mezzanine fund secondaries.

Follow-up discussions with LPs revealed three reasons for the interest in venture fund secondaries: the emerging value in venture portfolios that were formed during the technology boom but survived the downturn; the expected level of discounts; and the potential to access high quality US funds that rarely accept new primary investors.

Buyers are motivated primarily by performance but GP relationships and portfolio management are also important. Improving returns (91%) and reducing the J-Curve effect (82%) are the most important motives for LPs. large number of LPs also buy secondaries to increase exposure to preferred GPs (65%) and to access new funds (51%).A significant number of LPs buy secondaries to increase diversification (47%) and to deploy excess cash (35%).

Sellers are motivated primarily by the need to optimise investments, followed by strategy changes and capital requirements. Most sellers look to diversify poorly performing funds (64%) and to relocate cash to better performing funds (54%). Around a third of sellers are motivated by changes in investment or parent company changes (36%) or by the strategic decision to reduce the number of GP relationships (36%). The final significant motive for sellers is the need for cash (23%).

Price is still the most important criteria for buyers: a discount to Net Asset Value (NAV) is still regarded as essential (84%) in order to generate required returns from secondary investments. The ratio of committed/called up capital was regarded as the second most important criteria (80%). This metric was regarded as an indication of the upside potential of a fund. The efficiency of the sale and purchase process was highly ranked (76%) as LPs have been busier than ever in 2006 with primary commitments. Transaction size was also regarded as important (72%) due to the need to chase only those deals big enough to justify the effort of the process.