Institutional investors still in love with secondary PE market

The tide of institutional investors selling private equity interests on the secondary market shows no sign of ebbing.

Public pension funds are still big sellers, with most of the sellers this year based in North America. And an increasing number of investors are starting to sell interests in older funds, those they have had in their portfolios for 14 or 15 years.

Investors including the California Public Employees' Retirement System, Ontario Municipal Employees Retirement System and New York City Retirement Systems have sold private equity fund interests on the secondary market so far this year, and more sales are expected.

In the first half of 2012, $13 billion in private equity interests were sold on the secondary market worldwide, much of it by institutional investors, according to a recent report by Cogent Partners, Dallas. This is up from $11 billion in the second half of 2011.

Pension funds are the second most active sellers on the secondary market, with 20% of the transactions and 31% of the transaction value in the first half of the year, according to Cogent. Financial institutions are the biggest sellers, accounted for 34% of sellers by number and 33% by transaction value in the period.

In mid-July, CalPERS Chief Investment Officer Joe Dear said the $235 billion Sacramento-based fund had sold $1.5 billion of private equity interests on the secondary market, ending 23 private equity relationships.

Also in July, the Toronto-based C$55 billion (US$54.9 billion) OMERS sold to AXA Private Equity a portfolio of 11 private equity buyout funds with a total of about US$850 million in original commitments.

Officials at the New York City Retirement Systems, which is made up of five pension funds with total assets of $122 billion, sold a portfolio of 11 funds and nine general partners representing $976 million in original commitments in two roughly equal pieces — a bundle of limited partnership interests from three well-known private equity firms and a second tranche from six less well-known private equity managers, said Barry Miller, head of private equity for the Office Of NYC Comptroller John Liu, who oversees the pension funds.

“We have $13 billion of commitments in private equity in 160 funds and 110 managers,” said Larry Schloss, chief investment officer and deputy comptroller for asset management. “Barry and I looked at the portfolio and decided it needed to be repositioned. We had too many managers, some no longer strategic.”

Fund officials will continue to reassess the private equity portfolio and could sell more interests as a result.

The pension plans had 108 general partners before the sale and ended up with 99 general partners, excluding new managers, Mr. Miller said. Sold in the second tranche were funds of AEA, Ethos Private Equity, HM Equity Management, NewSpring Ventures, Tailwind Capital and Vitruvian Partners.

Although fund officials received bids for all of the fund interests they put up for sale, they withheld a portion of them because they did not get a good enough price, Mr. Schloss said.

Scott Higbee, partner in the New York office of private investment management firm Partners Group, said his firm saw some $70 billion in private equity interests that were being shopped last year. That's up from $65 billion in 2010, he said. “We would expect 2012 deal flow to meet or slightly exceed what we saw in 2011 by the end of this year.”

In the next two or three years, 63% of private equity investors expect to access the secondary market as either a buyer or seller, according to a survey by Coller Capital, London, that was released earlier this summer. And 60% said they had bought or sold on the private equity secondary market in the past. Coller is a private equity secondary market investment management firm.

What has driven the growth is the spike in fundraising between 2004 and 2007, said Michael Alfano, principal in Coller Capital's New York office. A lot of capital flowed into buyout funds raised during those years and investors are now pruning their portfolios, he said.

“Some portfolios that are for sale are just venture capital, some are all buyout funds and some investors are getting rid of special situation funds,” he said. Other investors are selling more mature, pre-2003 funds, he added.

But it's no question that that institutional investors have become big sellers, Mr. Alfano said.

And institutions are in the market despite the fact that they have to sell at a discount. The average high bid, which is the simple average of the highest bids received for each asset, was 80% of the reported net asset value, according to the Cogent Partners report. This is down from 81% of NAV in the second half of 2011.

Benoit Verbrugghe, senior managing director and head of AXA Private Equity U.S., New York, said sellers are using the secondary market to rebalance their portfolios.

CalPERS sold stakes in venture capital funds including Menlo Ventures, Draper Fisher Jurvetson, Austin Ventures, New Enterprise Associates and Lightspeed Venture Partners. It sold the portfolio in order to prune its list of managers.

OMERS Private Equity Inc., the private equity arm of the Ontario fund, announced the sale of buyout funds — most from 2005-2007 — and its unfunded commitments to AXA Private Equity on July 3. The 11 buyout funds were predominantly North American and global funds that OMERS sold as part of the fund's move to direct private equity investments.

More large deals from pension funds are on the horizon, said AXA Private Equity's Mr. Verbrugghe. He declined to name the sellers.

Deal flow is very dense, very important, he said.

These are not all new private equity interests being shopped, Mr. Higbee noted. “We are also seeing a number of tail-end portfolios (older fund interests) for sale.”

According to the Cogent Partners report, sales of interests in older private equity funds traditionally have been small, around $2 million per private equity fund or less. Now many experienced private equity investors are looking to sell larger portfolios of older investments. In the first half of 2012, sales of interests in private equity funds that were 2000 vintage or older accounted for 26% of the market.

To sell these older funds, sellers have to be ready to offer a big discount. Funds raised or closed in 2000 or earlier had an average high bid of 76% of the funds' NAV in the first half of this year.

But if the field of sellers is widening, the buyers are mainly still the 10 to 15 large secondary private equity investment managers, Mr. Verbrugghe said. “More than 85% to 90% of the market is composed of the usual player secondary funds,” he said.