The Volcker rule, finalized in December by five federal agencies, including the Securities and Exchange Commission, will have a major positive impact on the transaction volume of private equity and hedge fund limited partnership interests on the secondary market this year, contrary to the negative impact the pending nature of the rule had in 2013, according to a report by NYPPEX, a global securities firm specializing in the private equity secondary markets.
Transactions for interests in private equity and hedge funds on the secondary markets are expected to rise this year by 34% to $32.8 billion, even though there was a 7.1% drop to $24.5 billion in 2013, the report states.
The report attributes the decline in sales of private equity and hedge fund limited partnership interests last year primarily to a lack of supply as financial organizations delayed secondary sales until the Volcker rule was finalized.
However, the rebound of transaction volume of private equity and hedge fund limited partnership on the secondary markets would be driven in part by the July 21, 2015, deadline financial organizations have to divest private equity and hedge fund assets under the Volcker rule.
“Many banks simply preferred to hold most of their private equity and hedge fund assets, and will sell only if forced to do so by new regulations,” said Laurence G. Allen, managing member of NYPPEX, in an e-mail.
At the same time, the best-bid prices of limited partnership interests on the secondary market in 2013 increased by about 7.9% to 92.46 (expressed as a percentage of the fund's net asset value) for interests in all private equity fund strategies, led by buyout strategies, which averaged 103.54.
Median prices increased by about 9.1% to 76.26 for all private equity fund strategies.
NYPPEX projects that in 2014 prices will drop 5% to 7% and buyers will become more selective as secondary private equity supply increases.
“Our surprise prediction for 2014 is that private equity supply could get so intense, that two things could happen. First, buyers will become more selective and prices will decline,” Mr. Allen wrote. “Second, new transaction structuring techniques will be needed to process the high volumes, such as structured transactions where sellers continue to hold the assets but issue securities that sell off their economic rights.”
NYPPEX expects that the volume of secondary hedge fund transactions will increase modestly depending on regulatory scrutiny, performance and other factors relating to specific hedge funds, Mr. Allen noted.
Meanwhile, transactions in companies on the secondary market — specifically unregistered equity-related securities in private companies worldwide — rocketed in 2013 by 51% to about $12.4 billion from $8.2 billion in 2012. Booming sales of direct secondary interests in companies are expected to increase by about 55% to $19.3 billion, NYPPEX estimates.
By comparison, the previous high volume in private companies transactions on the secondary markets was $9.4 billion in 2011.
The NYPPEX report attributes the predicted increase in so-called direct secondary transactions in 2014 primarily to the needs of private equity and venture capital firms to exit their portfolio company investments worldwide.
Last year's increase in direct secondary transactions was in part due to private equity and venture capital funds seeking to sell, and institutional investors and wealthy families' desire to buy with capital they had allocated to the private equity and hedge fund secondary markets, NYPPEX estimates.
Prices for direct secondary transactions varied last year. U.S. portfolio companies performing well enough that the private equity fund had reasonable opportunities to exit its investment in the company had estimated bid prices between 6% and 19%, cheaper than valuation multiples of mergers and acquisitions for comparable companies, or about a 16% to 28% discount of projected internal rates of return, for secondary buyers as of year-end.
Discounts were higher for underperforming U.S. companies with uncertain exit opportunities — 22% or more compared to the transaction multiples of a merger and acquisition of a comparable company or roughly 32% or more of IRRs for secondary buyers as of year-end.
Outperforming U.S. companies with good exit possibilities had a secondary bid prices at (or above) comparable company merger and acquisition valuation multiples or about 12% to 26% projected IRRs for secondary buyers as of year-end.
Private equity fund assets in 2013 were sold in the Asia-Pacific, Latin America, Middle East and Eastern European regions.