Jeremy Coller was venture capital and buyout manager at London-based Imperial Chemical Industries PLC's pension fund when he formed London-based Coller Capital Ltd. in 1990. The private equity firm, which specializes in the secondary market, has been a leader in the purchase and sale of limited partnership stakes in private equity funds. Coller Capital's last fund closed in September 2002 with $2.6 billion and was the largest secondary fund raised at that time. The fund is now 50% invested. In January, Coller Capital bought the $1.33 billion private equity portfolio of Abbey National PLC, the largest secondary purchase by a single buyer. Mr. Coller spoke with P&I's Arleen Jacobius about recent estimates of the $35 billion potential growth of the secondary market and how he expects pension plans to become the largest group of sellers of private equity stakes in the United States.
Q Where will the secondary private equity market be in 12 to 18 months?
A I expect to see the acceleration of deal flow in different types of original investments. We see more tactical selling at the moment. Pension plans are becoming much more sophisticated, and a lot are seeing the public market as a sucker's rally. They are making tactical asset allocations by selling part of their portfolio. In England … there's been (legislative) changes in liquidity ratios. Banks have to take a more conservative approach to their private equity portfolios. … It's fair to say, every bank is questioning their private equity portfolio.
Q Have pension plans, endowments and foundations been sellers in the secondary private equity market?
A Pension plans, endowments and foundations have been buying ... Our investors include groups such as CalPERS and GM …There's been a wide range of endowments and foundations interested in the secondary market. Also, consultants are emphasizing active portfolio management.… I have not seen many pension funds selling. That's partly due to the fact that the manager of the pension plan does not get rewarded for selling.
Q So who's selling?
A Many (institutions) have reached their target asset allocation and it makes sense for the core relationships they want to move forward with…. The market's become much more sophisticated.… There's an underswell … with plans looking to reduce the number of relationships in private equity, especially…. More importantly, many are considering (selling). You have Harvard and others who have sold. The actual deals are very few, but pension plans are actively looking at doing it. Typically, pension plans have small teams, and either investors are looking to contract out management, or the sophisticated pension plans are debating the question. It's a hot topic. They are looking at it and that's the first step to action .
Q What are they selling?
A The structure of private equity is, if they commit, say, $10 million to a private equity fund, the private equity fund will draw down the capital over, let's say, over four years … and when a company is sold, the proceeds are not re-invested. They go back to investors. Every three to four years, a private equity group has to raise a new fund. What happens if the pension plan changes its asset allocation?…. Even if (the funds) have not performed up to expectations or have not provided co-investments ... there's a whole load of reasons they would sell. … Many pension plans are doing tactical as well as strategic asset allocation of their private equity portfolios.
Q What do you mean by tactical asset allocation?
A Remixing their overall private equity portfolio. It's active portfolio management instead of making investments and waiting for the natural end date of the fund many years later.
Q When did you first notice funds take a tactical approach to their private equity asset allocation?
A It's fairly new. They started as distressed sellers like Montgomery Ward out of Chicago… Montgomery Ward sold in the late 1990s. That was a distressed seller, which is different than tactical or active management. There, if I get the right price, I will sell … Consultants are encouraging pension plans to actively manage …. It's a way to describe that the stigma of selling has dissipated. Expectations are high. We believe the public market will decline after the election. … A very smart seller will say, ‘I missed the opportunity (to sell private equity stakes) a few years ago. I have another opportunity to do it, and the window will close shortly.' One year from now, there will be a vibrant secondary market.
Q Who is buying?
A It depends on the price. You would've been crazy to sell Microsoft shares in 1990, but there were willing buyers and willing sellers of the shares because people had asset allocation issues because they felt Microsoft was overvalued. Secondaries came out of the vulture mode in the '80s and are now seen as an asset allocation tool. It's becoming a genuine market. Estimates are that everything is half a percent to 3% recycled every year, out of $1.2 trillion (in the private equity market) … Who knows. It's a guess. What we can say is there is increasing volume every year.
Q Why do you say secondary private equity is the flavor of the month now?
A There's no doubt about that…. There are two advantages to institutional investors in the secondary market.… Since 1990, there's been $1 (trillion) to $2 trillion raised for private equity funds. Now, there's a large invested capital base. Since 2000, it's really been ramping up.… What that indicates is the size of the market is growing, and also the $100 (million), $200 (million), $300 million transactions are becoming the norm. It's becoming just the same as any other market. There are a lot of transactions and therefore, that size of transaction is fairly routine. That's not to say there aren't lots of small transactions, and that won't go away. There's such a big range of everyday deals. For example, we bought a Japanese fund for $1.8 million. We bought six positions for a total of $800 million in a U.S. fund.
Q Are you planning to raise another fund?
A We raised $2.6 billion in 2002, and that's still the largest secondary private equity fund ever raised. We're focusing on investing our current fund, which is just over 50% invested.
Q Was $2.6 billion too big?
A We invested over half, which is pretty striking, and it's the answer to the question. It was an experiment, raising that size fund. It was much larger than anything before. Our previous fund was $1.2 billion. The investors are very satisfied and comfortable because the investment pace has been right for this size. I believe the experiment was successful.
Q Do you think it opened the door to even larger secondary private equity funds?
A That's something we'll assess when the fund is fully invested. If we invest the rest in three months, which is unlikely, it is different than if it takes two years.
Q How did you build the business?
A It sort of reflected the market in a way. It started in 1990. It took four years to raise $50 million. It took a wing and a prayer to get (that) $50 million raised. We just opened an office in New York and only have three investment professionals at the moment. Private equity is a very localized business, and an opportunity business. It's not a matter of having offices in a lot of places; it's more of having an internal team…. We're institutionalizing the business. It's a whole art, moving from being an entrepreneur.