Secondary rally could suffocate primary fund-raisers

Firms looking to raise new funds in 2010 will face competition not only from their pledge-seeking peers but from the secondary market, as well.

Rising prices for secondary interests, a sizable pool of interests for sale, and a host of new buyers hitting the market are generating more activity in the secondary sector, which in turn is threatening to divert hundreds of millions, if not billions, of dollars away from the primary fund market in the coming year.

Several limited partners plan to raise their exposure to the secondary market next year—either through dedicated funds or by cherry-picking interests on the secondary market—at the expense of commitments they may have made in the primary market.

That’s not welcome news in a fund-raising market that’s already in the doldrums. In the first 11 months of 2009, U.S. buyout and mezzanine firms raised little more than $60 billion in new commitments, compared with nearly $250 billion during the same period in 2008.

Five LPs recently polled by Buyouts, a PE Week affiliate publication, said that any investments they make in the secondary market next year will reduce the amount they commit to new funds.

Of that group, three investors—Guardian Life Insurance Company of America, the Tennessee Consolidated Retirement System and the Universities Superannuation Scheme—said they have already decided on, or are considering, increasing their allocations to the secondary market next year.

A fourth LP, the Chicago Firemen’s Annuity and Benefit Fund, plans to reduce its overall commitment to secondaries in 2010 to $10 million from $15 million in 2009, although any secondary pledges it does make will likely offset commitments to primary funds on a dollar-for-dollar basis, according to Mike Moran, CIO of Firemen’s Annuity.

Meanwhile, according to secondary firm Coller Capital’s most recent survey, “Global Private Equity Barometer,” 32% of the 108 LPs surveyed said they expect to invest more in secondaries in the next two years, while another 37% said they will at least hold their exposure steady at current levels.

Another recent report by San Francisco-based placement agent Probitas Partners said there is about $21 billion in secondary pools either already in the fund-raising market or expected to be in 2010.

Several of the vehicles listed in the report, including Coller Capital’s $6 billion-targeted Coller International Partners VI and Lexington Partners’ $5 billion-targeted Lexington Capital Partners VII, are aiming for more dry powder than most new buyout funds in the market.

In October, the Maine Public Employees Retirement System tapped investment consultant Cliffwater to help it invest $100 million over the next two years in what it calls “young secondaries,” or funds in which capital commitments are not completely drawn down. The LP, which made its first private equity investment in the summer, will likely use the strategy to help it lay a foundation for its portfolio.

However, industry pros believe there should be more than enough supply to meet the growing demand. “Given that trillions of dollars have been committed to PE over the last six to seven years, even if one assumes a very modest churn into the secondary market, this demand clearly outstrips the estimated $30 billion of capital sitting in secondary funds which is to be deployed over the next two to three years,” said Luca Salvato, a principal at Coller Capital. —Ari Nathanson