ALTERNATIVES

Private equity secondaries drop in 2016, 3 reports find

Transactions on the private equity secondary market fell in 2016, secondary broker data released by NYPPEX, Setter Capital and investment bank Evercore reveal.

However, the data predict that secondary market volume will pick up in 2017.

NYPPEX estimates the value of transactions fell 7% to $37.7 billion in 2016 from $40.6 billion in 2015.

Despite lower returns and fewer distributions, and given the lack of secondary supply in 2016, the secondary market high bid increased 7.6% on average to 104.95% of net asset value as of Dec. 31 compared to 98.02% of net asset value as of Dec. 31, 2015.

An increasing percentage of the limited partnership interests sold were of funds at the end of their fund lives, NYPPEX data show.

In 2016, tail-end funds made up about 52% of total secondary limited partnership interest volume, compared to 43% in 2015 and 35% in 2014, according to NYPPEX. Tail-end funds are funds that are more than nine years old and/or funds with less than 30% unrealized value as a proportion of total contributed capital.

In a separate report, Setter Capital estimates transaction volume declined by 15% to $42.15 billion in 2016. The 10 largest buyers, those that invested more than $1 billion, accounted for 58.4% of total volume, according to Setter Capital's most recent volume report.

Large buyers had the most challenging year, with their total purchases down 19.9% to $24.6 billion in 2016, the report said.

In a third report, Evercore Partners states that transaction volume was down 12% in 2016 to $37 billion. Evercore estimates that dry powder totaled $90 billion on Dec. 31.

While transaction volume was lower in 2016, transaction volume in January has already picked up because investors are now willing to accept lower returns, said Kishore Kansal, managing partner of London-based secondary markets broker PEFOX, said in an email.

“At this point, buyers are underwriting secondaries to perhaps the lowest returns in history,” Mr. Kansal wrote. “Driving this is what can only be described as clear desperation amongst many groups to put money to work.”

There is a significant amount of uncalled capital available to secondary market buyers, which is compounded by lower deal volume in 2016, Mr. Kansal said.

In 2017, NYPPEX estimates that secondary supply of limited partner interests in funds will increase and secondary volume will also increase by 10% or more to $41.4 billion, exceeding the $40.6 billion in deals in 2015.

The reasons include that limited partners will need to become more active private equity portfolio managers to capture higher returns, wrote Laurence G. Allen, managing member and CEO of NYPPEX, in an email.

The limited partners also have less incentive to wait to sell on the secondary market because they have less cash than they had in 2015, expect fewer distributions and believe that secondary prices peaked in the third or fourth quarter of 2016, Mr. Allen said.

NYPPEX estimates that secondary buyers have a combined $60 billion in dry powder.

“We are now seeing a number of double-digit premiums in the market, and the early signs for 2017 are that the buyers have now blinked first and are ready to pay what it takes to get deals done,” Mr. Kansal said.