“Selling private equity at 40 per cent discounts to NAV – which hadn’t actually been marked down – was no different to selling equities at the bottom of the market,” Weaver says. “I didn’t see too many people wanting to sell equities when they were 50 per cent of what they used to be. So to say equities are fantastically liquid isn’t true.” Direct deals King, at Sovereign, says a healthy expectation of net returns from a secondary investment should be 15 per cent because “a number of years of uncertainty” have been taken out of the asset. It follows that he expects net returns of about 20 per cent from primary private equity investments. Returns from secondary investments are a function of multiple dynamics, he says. “Returns aren’t based on what price you pay. It’s the earnings growth that gets generated, the value of the business that gets generated and the quality of the exit process.”

King disaggregates the market into two sections: “mega” deals, in which the vendor is a bank or insurance company executing large portfolio trades; and smaller deals, where investors group small- and mid-sized managers together. Some investors view secondaries as a way to access top-tier primary private equity managers. “They don’t necessarily want serious discounts to NAV; they’re willing to pay NAV or even go above NAV,” King says. A defining characteristic of the market is its inefficiency. “The sellers have a lot of inside knowledge; they are almost insider traders. They know so much about these assets. They’ve sat on advisory committees; they’ve been watching these assets for years,” he says. “You’re a buyer and trying to strike a price for something where you know the seller is all over you in terms of information. That is a real issue that people are overlooking.” Sellers of LP interests are obliged to fully disclose the quarterly business and financial updates they receive from the relevant private equity manager, the general partner (GP), Penn says. This is usually the most information they have about the assets. GPs keep information about underlying portfolio companies “very tight,” he says.

“What LPs don’t get are the audits, the investor rights agreement, the bylaws of the company. So there is a reliance on the GP.” Penn says portfolio companies often do not want a GP to release such minutiae to their investors. The companies believe that this information, if circulated among investors, could get out into the market and hurt their competitiveness. But investors want these details. “So that’s a natural fight between companies and the GP, and the GP and its broader partnership,” he says. Penn believes this level of information is insufficient for investors. “When you run partnerships, every three to six months there are changes. There are companies that grow fast, have problems or are about to go bankrupt,” he says. “So when we price an LP interest without the detail of an underlying portfolio company, pricing is really skewed. “Focusing on the asset, and repricing that asset at a point in time, is really the most important thing about the secondary market.