The secondary market for private equity harbours a diverse range of investment opportunities. But how should superannuation funds approach this market: by acquiring commitments made by other private equity investors or by targeting the underlying portfolio companies in these programs? Investment Magazine put this question to investment professionals in a roundtable supported by The Camelot Group LLC. Simon Mumme reports.
In the past 25 years the secondary market for private equity has evolved from one in which investors
could occasionally shed their commitments into an arena where specialist managers now target underlying companies held in limited partnership (LP) interests. Ray King, managing director of Sovereign Investment Research, began recommending secondary deals to Australian institutional investors in the late 1990s; and in subsequent years some superannuation funds have committed to specialist “secondaries” managers. But how should investors approach the market as it continues to attract more participants: should they search for the most attractively priced LP interests on offer from well-regarded managers; or should they undertake some heavy-duty due diligence and invest directly in the underlying companies in these programs?
It’s unlikely that there will be any shortage of deals through either channel. The Camelot Group LLC, a private equity secondaries specialist based in New York, forecasts that the market will grow to about $49.5 billion by 2014. Some of this growth will be caused by new legislation – such as the Basel III laws, forcing banks to hold deeper liquidity reserves, and the Volcker Rule, which, among other conditions, prevents US banks from investing in private equity – which is likely to force many financial institutions to offer their private equity investments on the secondary market. Expectations of the coming deluge in secondary deal-flow range from about $300 billion from the US market and $200 billion from Europe, according to Frontier Investment Consulting. Joey Alcock, a consultant with Frontier, says the process will not be smooth. “Some of the secondaries managers would have you believe that banks are going to sell, wholesale, in the next few months,” Alcock says.
“I think it’s going to take a lot longer than that. There will be deal-flow, but it’s important to capture the right assets.” Allison Hill, senior consultant with Frontier, says “sophisticated” secondaries managers will have opportunities to negotiate advantageous prices by structuring direct deals, rather than buying LP interests on offer, as assets come to market. However, a more significant catalyst for growth in the secondaries market is the undeniable need for liquidity among defined benefit pension funds in the US, says Lawrence Penn III, a managing director at Camelot. “You’re talking about tens of millions of baby boomers who will be calling on the police, fire, teacher and other pension funds,” Penn says.