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The report, entitled “Private Equity Liquidity – A Work in Progress”, finds that nearly half of general partners and a third of limited partners and consultants agreed that the private equity market was “more liquid than it used to be”. The trend of institutional investors seeking greater liquidity provisions is symptomatic of the wider alternatives industry where, in recent years, there has been a concerted drive towards negotiating improved liquidity provisions and more transparent reporting; particularly in respect to hedge funds as institutions build bespoke mandates. Moreover, the desire for liquidity has led to the growth of the liquid alternatives marketplace.
The figures above are an early indication that those same needs are starting to filter in to private equity. According to the SEI report, this liquidity injection is occurring in three ways: the growth of the secondary market, the listed private equity market, and retail funds. Combined, they are helping to ease the liquidity constraints that have long been the preserve of public equity.
Of particular import seems to be a burgeoning secondary market, which is providing investors with the opportunity to sell assets without fear of taboo given that this activity was, historically speaking, often associated with the forced selling of toxic assets at heavy discounts. That perception is now changing as the secondary market shifts from a niche to a mainstream activity. According to SEI, 58 per cent of investors either bought or sold assets on the secondary market. In addition, 38 per cent said they planned to buy secondary assets in 2015.
As Giles Travers, Director, Alternative Investment Funds at SEI Investment Manager Services in London comments, the secondary market has been the most mature vehicle for PE liquidity. Total global transactions in 2014 reached record levels of USD42 billion and according to Preqin, 2015 could see another all-time high being achieved. “Private equity has traditionally required ‘patient’ capital from investors; LPs willing to commit long-term funding due to the time required by GPs to find, manage and realise superior returns in illiquid assets. However, as the industry has evolved, so has liquidity in the form of a growing secondary market and a variety of investment options in private equity whether it be listed private equity or private equity’s experiments in the retail market,” says Travers.
From an LP buyer’s perspective, the secondary market provides another avenue to access private equity returns with the potential to avoid the fees and costs associated of being a day one LP. From a seller’s perspective, many investors are rebalancing their private equity portfolios from a risk and regulatory requirement and the taboo of leaving early is no longer viewed as major breakdown in the relationship between investor and manager according to Travers, who adds: “On the GP side, private equity managers are becoming increasingly diversified asset managers, encompassing strategies such as credit, distressed, and infrastructure and even other asset classes including hedge. Developing a wider array of investment structures and liquidity options for their investors enables GPs to provide a more flexible investment platform for their LPs. As the duration of private equity funds has also increased post-crisis, the secondary market has enabled GPs to hold portfolio companies longer and find further funding with the aim of securing more fortuitous exits.”
Whilst the rising levels of dry powder – capital committed to PE funds but yet to be invested – are expected to keep demand for secondaries strong, Christopher Elvin, Head of Private Equity Products at Preqin told Hedgeweek recently that the ability to find attractive investment opportunities is set to be challenging, which managers fear could negatively impact on performance. Fifty-four percent of those surveyed by Preqin felt that the level of competition for PE transactions had increased year-on-year.
In SEI’s report, they write that the supply side of the secondary market is healthy “in part because regulatory changes are compelling banks and other financial institutions to divest some holdings”. Fund-of-funds are particularly attracted to the PE secondary market with 80 per cent surveyed by SEI confirming that they use it to find assets. The recent growth, says Travers, has been helped by self-confirming success – as deal flow has increased, prices have risen, “encouraging buyers and sellers alike to consider the secondary market as an attractive market”. The recent surge is also underpinned by the eagerness of LPs to invest in private equity in the search for yield.
Whilst the hunt for returns is not surprising, Travers says that it is interesting to note that many LPs still decide to do this directly rather than through investing in a secondary fund.
“In our SEI survey, as well as other market research, direct and intermediary advised purchases are the preferred route to market. The opportunity for secondary managers is attracting LPs to their funds on the basis that enhanced returns are more likely with a specialised manager with the requisite analytical talent and resource,” confirms Travers.