What happened to secondary deal flow in the second half last year?

Deal activity in the red-hot secondaries market cooled off in the second half of 2019 as many of the largest buyers stepped back after spending big money in the early months of the year.

The value of completed transactions was $39.4 billion in the second half, down 14 percent from the first half of 2019, according to secondaries adviser Setter Capital in its full-year secondary volume report. The number of deals in the second half also declined compared with the earlier period, Buyouts reported.

Overall, total deal volume in 2019 came in between $80 billion and $85 billion, according to full-year volume reports from Setter and Evercore. While a record high for the secondary market, the totals came in under many predictions that put total deal volume over $90 billion.

So what happened? Most sources agree that buyers spent much of their capital in the first half, which tallied around $42 billion of total volume, according to half-year volume surveys published last summer. By the second half, and especially the fourth quarter, many buyers decided to hold off until this year.

This is because GPs don’t want to spend too much capital in any given year out of a fund with a finite investment period, according to Jeffrey Keay, managing director with HarbourVest Partners. GPs try to achieve a certain level of “time diversification in terms of deploying the fund evenly, typically in a three-year period at minimum, you’re comfortable at four years, and maybe even a five-year period,” Keay said.

Deployment pace “is a compass, maybe not a rigid guide, on how much capital they should be investing over a given window of time,” Keay said.

Despite the pullback by buyers, sellers continued to bring inventory to the market, creating a supply/demand imbalance. Anecdotally, this led to a softening in pricing, sources said.

The secondaries market is still growing, and while fund sizes have expanded in recent years, supply still outpaces demand, sources said.

“There’s been a larger volume of opportunities in the last couple years than many people calibrated when they raised their funds,” Keay said. “Those funds feel undersized relative to the market opportunity that exists today, that’s why you see the growth and size of secondary funds.”

Also contributing to the slowdown was the fact that many of the largest secondary buyers were fundraising last year, including Ardian, Lexington Partners, HarbourVest and others, according to Nigel Dawn, senior managing director and head of private capital advisory at Evercore.

Buyers also became much pickier later in the year because they had reached deployment pace, Dawn said. “Their bar in terms of the deals they would look at went up a lot,” he said.

Despite the slowdown in the second half, the market in 2019 was still busier than it’s ever been. So it could just be nitpicking by focusing on the slowdown in the later half of the year. But the question becomes, will that sluggishness continue into this year?

Apparently, the answer is no. The market has kicked off 2020 as busy as ever, Dawn and Keay said. Driving activity now are large LP portfolios, which generally don’t hit the market until later in the year, Dawn said. This is because sellers like to get full-year performance marks on their portfolios before selling.

But some sellers waited last year to bring portfolios to market until buyers were ready to start spending again.