New opportunities in private equity secondary market

Managers making nascent moves in timber, energy, infrastructure

021714 allen
Laurence Allen sees high secondary demand for real estate and infrastructure.

Money managers are expanding their private equity secondary market investments to include infrastructure, real estate, energy and timber, ahead of what they expect to be a growing investment opportunity.

Industry insiders predict at least 2% of the assets committed to infrastructure, real estate, energy and timber funds could be sold on secondary markets. These newer markets could quickly blossom to an estimated $9 billion to $12 billion. Growth in these markets could add liquidity, making it easier for investors to manage their real asset portfolios.

“Our deal flow suggests this is a multibillion-dollar opportunity” annually, said Thomas Kerr, managing director and head of secondary investment activities at Hamilton Lane, Bala Cynwyd, Pa., an alternative investment consultant and money manager.

Last year, Hamilton Lane closed its third fund to invest in alternative investment secondary markets, at $900 million. The fund was one of the largest raised in the secondary markets last year, according to data from alternative investment research firm Preqin in London.

Makes sense

Managers had long believed it would make sense for large investors in alternative investments to use the secondary market to manage their portfolios and dispose of unwanted interests in funds. It did not become a potentially viable business until the Great Recession prompted sales of interests in alternative asset classes other than private equity.

Now, managers are moving into the market, anticipating potential inventory from the surge in real asset funds raised in the past few years.

Among the firms that have moved beyond private equity, adding capabilities to invest in the secondary markets of other asset classes are Ardian, HarbourVest Partners LLC, Landmark Partners, Pantheon Ventures, Partners Group AG, Neuberger Berman Group LLC and Macquarie Group.

Also, with last year's acquisition of $2.6 billion global real estate funds-of-funds manager Metropolitan Real Estate Equity Management LLC, The Carlyle Group now has added investment in the real estate secondary markets to its private equity secondary market and funds-of-funds business, AlpInvest Partners.

And, Blackstone Group in August acquired Credit Suisse's $10 billion private equity secondary market funds-of-funds subsidiary, Strategic Partners, which also invests in real estate.

Putting its strategy into action, last September Ardian, the AXA Group spinout formerly known as AXA Private Equity bought a 9.9% share of F2i SGR, an Italian infrastructure fund, from Merrill Lynch for e150 million ($205 million).

HarbourVest is expanding beyond private equity into real assets secondaries, said Brett Gordon, Boston-based managing director. HarbourVest has more than $30 billion in total AUM.

“We believe the real asset secondaries is an exciting space,” Mr. Gordon said in an interview.

There is a great deal of money being raised on the primary side for funds in the asset class including real estate, infrastructure, energy and timber. Plus, there are a growing number of sellers but not as many buyers as in the private equity secondary market, he said.

“In private equity, if an agent is selling a limited partnership interest or a portfolio of limited partnership interests, it is easy to come up with 50 to 60 people to talk to,” Mr. Gordon said. “In infrastructure, energy, timber and real estate, there are fewer than a dozen credible buyers.”

Pantheon was an early mover into the infrastructure secondary market, said Kathryn Leaf Wilmes, partner and head of infrastructure. The firm started pursuing infrastructure secondaries in 2008, but the market opportunity didn't really begin to open up until 2010, she added.

Now, Pantheon is expanding into other real assets such as natural resources, timber and agriculture, Ms. Leaf Wilmes said.

“As real-asset fundraising explodes, the secondary opportunity is not far behind,” she said.

Laurence G. Allen, managing member of secondary market brokerage firm NYPPEX LLC., Rye Brook, N.Y., in an e-mail said: “We are seeing high secondary transaction volumes in real estate funds, followed by energy, infrastructure, then the lowest volumes in timber funds. In particular, there is a lot of secondary demand in 2014 for real estate and infrastructure funds, as institutions want to add these "stable cash flow' funds and are willing to forgo some capital appreciation from venture, etc.”

Indeed, institutional investors also are starting to sell limited partnership interests in other asset classes along with their interests in private equity funds.

In November, the $40.8 billion Teachers' Retirement System of the State of Illinois, Springfield, put about $500 million in private equity and real estate fund interests in limited partnerships up for sale. In an e-mail, David Urbanek, director of communications for Illinois Teachers, declined comment.

Portfolio sold

In July, the New Jersey Division of Investment, Trenton, which manages investments of the $76.8 billion New Jersey Pension Fund, sold a portfolio of up to 25 real estate limited partnership interests from about 16 managers, representing 27.36% of the division's real estate portfolio, for about $925 million to NorthStar Realty Finance Corp.and Goldman Sachs Asset Management.

“The secondary market has evolved to include a broader set of alternative assets beyond buyout and venture capital funds, particularly over the past five years,” Hamilton Lane's Mr. Kerr said. “Investors are actively managing exposure in their alternatives portfolio, so we are seeing secondary sales of asset classes that were traditionally buy and hold.”

Hamilton Lane's recent secondary market fund is investing in energy and infrastructure deals in addition to private equity, Mr. Kerr said. Typically, the firm does not invest in many real estate deals in its secondary market funds, but Hamilton Lane has other pools of capital that can invest in real estate, as well as energy, infrastructure and timber, through the secondary markets, he noted.

“From an investor perspective, secondaries in these strategies offer similar advantages to private equity secondaries — such as diversification and J-curve mitigation — so there is definite interest,” Mr. Kerr said. (The J-curve refers to returns that tend to be negative in the early years of an investment fund's life, with returns generally moving up into positive territory around the fifth year.)

Managers are looking to bring their secondary buying expertise into these new domains, said Peter McGrath, president of Toronto-based alternative investment secondary market brokerage firm Setter Capital Inc.

So far, the secondary markets are small: Last year, there was $700 million in infrastructure, $200 million in timber and $5.1 billion in real estate traded on the secondary markets, according to the 2013 Setter Capital Volume Report. By comparison, total private equity secondary volume was $27.9 billion.

However, these markets are expected to expand, as the total outstanding fund interests continues to expand and mature, he said.

“As years pass, more money will be raised, which means more legacy assets to be sold on the secondary markets in the future,” Mr. McGrath said. n

This article originally appeared in the February 17, 2014 print issue as, "New opportunities in secondary market".