Private equity assets are being sold at a record pace in an opaque secondary marketplace, investors claim. Asset managers seek to rebalance their portfolios and cover losses elsewhere.
This wave of selling represents one of many signs that stress is affecting private markets. It is also a sign of investors falling out of love for “alternative assets”, which were only recently able to draw in cash.
Private investments were originally created to be an easy, but profitable way of accessing non-listed companies. They are usually structured as funds managed by buyout firms. They have grown to include infrastructure and property as well.
However, such funds can be difficult to sell before their maturity date – typically at least three to five years. Money managers who need to cash out these funds use secondary markets that have been active in recent months.
Discounts on offer indicate a rush to leave. Total turnover, although difficult to measure because deals are privately negotiated, is near or equal to record levels.
Hamilton Lane, an investment firm claims that $224 billion worth of private equity shares have been sold in the secondary market between mid-November and now.
Although not all were sold, Preqin analysis estimates that the secondary transaction value up to the third quarter of 2018 was approximately $65 billion. It is comparable to 2021’s value of $70 billion, and much higher than in previous years.
According to market participants, there are many factors that drive selling.
Investors sometimes need cash. Participants in the market pointed out the September meltdown of Britain’s Debt Markets, where investors had to pay back losses. They turned to private equity to help them.
Other people want to put their capital somewhere else, which is a signal that private equity funds have fallen from high esteem.
There are also pension funds which are forced to adhere to their allocation caps for such investments. These are the largest sellers.
What do you do if your target allocation is 5% but suddenly, you’ve got fair market value of 10%? Alistair Watson is head of strategy innovation in private equity for fund manager abrdn.
When, like this year, the performance of private equity funds outperforms public markets, it is possible to need to sell in order to rebalance.
Watson stated that the challenge when trying to quickly sell assets to fix target allocation is that you are generally selling them in volatile times and secondary pricing might not be optimal.
Buyers are accustomed to receiving modest discounts on book values in steady times. However, these numbers have risen dramatically recently.
A portfolio would typically trade close to its book value, with a 1- to 2-percent discount. These portfolios of top quality are trading today at double-digit discounts,” Jan Philipp Schmitz of Ardian (one of the largest players in private equity secondary markets) said.
He said, “As buyer, it is possible to be extremely picky.”
Private investments that are usually valued every quarter appear to be doing well on paper. There are some signs that sentiment is changing.
The Financial Times reported that Carlyle Group, a U.S.-based buyout company, is having difficulty meeting its fund-raising goals.
The Blackstone unlisted real estate trust is also under pressure. This trust has seen its value increase this year and is widely held. After redemption limits have been reached, it has limited withdrawals.
Nevertheless, many people are content with holding on to private investments.
For example, Thailand’s government pension funds has seen the percentage of their portfolio that is invested in private assets grow from 5% to 18% eight years ago, Man Juttijudata (deputy secretary general for the fund’s external fund management group), told Reuters.
He said, “It provides good long-term returns with acceptable risk levels. It is less volatile than main assets.”
Analysis by U.S. bank Jefferies revealed that 58% (by value) of the secondary market deals in 2022 was sold by private equity funds. Participants see greater selling pressure.
Vikas Pershad (portfolio manager Asian Equities, British Fund Manager M&G Investments, Singapore) stated that there are still companies I believe are too high-rated.
“I believe people need to be more realistic.”