Tax-exempt institutional investors have pumped $4.5 billion into the secondary private equity market during the past year, more than double the $2.1 billion they invested in 2000.
More secondary offerings are available because banks, insurance companies and wealthy individuals have been reducing their exposure and selling their portfolios.
Firms that specialize in structuring secondary private equity partnerships have been buying them up. Some big pension funds with substantial private equity programs have also been taking advantage of lower valuations and investing directly with the general partners.
In fact, four pension funds were lead investors in the largest private equity secondary transaction to date. About two weeks ago, the $68 billion Ontario Teachers' Pension Plan, through its merchant bank unit, along with the $9.4 billion Canadian Pension Plan Investment Board and NIB Capital Private Equity, were lead investors in a $2.8 billion divestiture of Deutsche Bank's private equity portfolio. Amsterdam-based NIB is a money manager formed by two Dutch pension funds, the e149 billion Stichting Pensioenfonds ABP and e50 billion Pensioenfonds PGGM.
Mark Weisdorf, vice president private market investments at the CPPIB, Toronto, said the fund usually doesn't co-invest in the secondary market, preferring to invest through funds. Executives made an exception because two of the board's managers - NIB and Paul Capital Partners, San Francisco - invested "a significant amount of their own capital," he said.
The CPPIB has around 15% of its $3.5 billion private equity portfolio in secondaries.
"We like secondaries because 70% to 80% of the capital has already been drawn down," Mr. Weisdorf explained. "The investment phase is over and the managers are focusing on exits. Secondaries also help returns; they dampen the early part of the J curve (returns are negative when a fund starts out because it hasn't returned anything yet). In addition, you're less dependent on manager skills in secondary investments and more dependent on the underlying portfolios."
The Deutsche Bank portfolio was also attractive because it "had been accounted for on a conservative basis. We tend to be more interested in late-stage buyouts with revenues, earnings and cash flow."
Officials at the $92 billion California State Teachers' Retirement System, Sacramento, also like secondaries, preferring to participate by co-investing in partnerships, said Christopher Ailman, chief investment officer.
"We're particularly interested in adding to the names we have," Mr. Ailman said. "If we bought the original partnership at 100 cents on the dollar and can buy an additional interest at 70 cents on the dollar a few years later, it will improve returns."
In the secondary market, he noted, "the companies in the portfolios are partially built.... There's more information about the portfolio companies, and it's a way to buy into a partnership at a discount." As of June 30 (the most recent data available), CalSTRS had 2% of its $4.5 billion private equity program committed to secondaries.
Other funds also like to invest in top partnerships at bargain prices.
David Kushner, deputy director for investments at the $10 billion San Francisco City & County Employees' Retirement System, said: "A lot of opportunities are being created by wealthy individuals who invested in 10-year partnerships during the heyday of the Internet and who now can't meet their capital calls. We've taken over some of those commitments on a spotty basis, adding to partnerships we already have.
"We will buy from a distressed seller, but we won't buy a distressed investment. In one case we picked up a $135,000 investment for $42,000 in an existing venture partnership."
The San Francisco system has invested around $50 million in secondaries over the last five years.
David Park, a partner at Paul Capital Partners, said pension funds have shown greater interest in the past year in investing in secondaries because they offer a lower-risk approach to private equity plus near-term cash flow.
Secondaries can also provide diversification in terms of vintage years (the year the fund was launched) and general partners, Mr. Park said. "Over the last five or six years we have owned 100 different partnerships with more than 1,000 different companies."
Some pension funds are investing in secondaries for the first time. Jay Fewel, senior investment officer for equities at the $33 billion Oregon Public Employees Retirement Fund, Salem, said the system committed $50 million to Coller Capital International IV. "As people have been peeling off their investments in private equity, the prices are good. If we weren't overallocated to private equity, we would look at other secondaries."
Mr. Fewel said his fund didn't invest in secondary private equity before because there were fewer funds being raised and the system couldn't spread itself too thin. Oregon has around $3.5 billion invested in private equity.
Still, the secondary market accounts for only around 7% of the total $38.5 billion raised in private equity in 2002, according to Venture Economics in Newark, N.J.
Pension funds aren't often among the sellers. But Tim Jones, investment director at Coller Capital, London, noted that his firm bought the Shell Oil Co. pension fund's $200 million private equity portfolio in 1998 when Shell officials decided to get out of that asset class.