Institutional investors are becoming the dominant buyers on the private equity secondary market as prices of private equity limited partnership interests are continuing to drop, according to a new study by Cogent Partners, a Dallas-based firm that helps investors sell interests on the secondary market.
The study showed that in the first half of 2009, the value of private equity fund interests sold on the secondary market fell to an average high bid of 39.6%, down from 61% of net asset value in the second half of 2008.
An average of the median bid, as a percent of net asset value, also fell in the first half of this year, to 35.7% from 55.2%.
The average low bid fell to 31.6% from 50.1% of NAV during the same period.
The study was taken from more than 200 private equity partnership interests marketed from January to June 2009, representing about $2.5 billion in transactions. Funds included in the sample consisted of 61% buyout funds, 22% venture capital funds and 17% other funds.
Institutional investors are replacing private equity firms that specialize in investing on the secondary market and fund-of-funds as buyers of secondary interests, said Colin McGrady, managing director and co-author of the study.
In the first six months of 2009, so-called non-traditional buyers — pension funds, foundations, endowments, general partners buying back interests, insurance companies and family offices among others — were buyers in 43.1% of the transactions.
Of the group, pension funds accounted 36.8% of the transactions; endowments, 11%; foundations, 11%; and family offices 15.8%.
“It's a huge development,” noted Scott A. Myers, managing director at Cogent Partners. “The (pension) funds had been talking about it for a long time but they had not gotten their ducks in a row until now.”
Institutional investors have a lower cost of capital, which means they can pay more for private equity interests on the secondary market, Mr. Myers said. They also expect a lower rate of return — 12% to 15% — than a secondary private equity fund, which shoots for an internal rate of return at 20% to 25%. The higher the expected return, the lower the price a buyer can afford to pay, Mr. Myers explained. This means an institutional investor may be willing to pay more than a specialty private equity firm for interests in a fund they need to fill in holes in their portfolios.
Private equity firms that specialize in the secondary markets also are most interested in buying limited partnership interests in funds that are almost fully committed, said Frank Morgan, president of Coller Capital U.S., New York. Coller is one of the largest private equity fund managers specializing in the secondary market.
The majority of sellers were institutional investors, pruning their portfolios to get liquidity.