A huge number of exits, and the record amount of dry powder secondary investors hold, are driving up private equity secondary market prices, raising concerns about what the future holds.
At one extreme are researchers at NYPPEX LLC, a Rye Brook, N.Y.-based private equity secondary market brokerage firm. Officials there expect a price correction of 5% to 7% in the private equity secondary market sometime in the second half of this year. The problem, they say, is that investors are failing to appropriately price risk.
Not everyone goes that far.
David Fann, president and CEO of private equity consulting firm TorreyCove Capital Partners, San Diego, and Thomas J. Kerr, managing director of consulting and money management firm Hamilton Lane Advisors LLC, Bala Cynwyd, Pa., do not see a bubble about to burst, but both agree the private equity secondary market is frothy.
“I think there are more buyers of secondaries than sellers right now. In order for a correction to occur, the supply demand characteristics need to shift,” Mr. Fann said.
And this shift will occur as a byproduct of trouble in the global market, they say.
“The secondary market won't correct absent a correction in the broader markets,” Mr. Kerr said. “The exit environment for PE-backed companies remains very attractive and, until that changes, the market will continue to be robust.“
At least $37 billion of unspent capital commitments exist in the private equity secondary market, NYPPEX officials estimate, with a crop of new buyers — including sovereign wealth funds and new private equity managers that specialize in the secondary market — driving prices ever skyward. Meanwhile, many firms are piling debt onto their positions in private equity fund limited partnership interests, adding more leverage to an already leveraged investment, industry experts note. ”Pricing has continued to increase, fueled by cheap financing, record levels of fundraising and the expectation that markets will continue to rise,” Mr. Kerr in an e-mailed response to questions. “High prices bring about more sellers, and there are plenty of buyers eager to put capital to work.”
At the same time, the spread between private equity funds on the secondary market and U.S. government bonds is the tightest since 2007, said Laurence G. Allen, managing member of NYPPEX. This tight spread between high-risk and low-risk assets is one indication that there is bubble in the private equity secondary market, leading to a market correction later this year, he said.
“Investors are not adequately pricing risk, which is driving secondary prices higher,” Mr. Allen said.
In the first half of this year, for example, the secondary high price of private equity fund-of-funds limited partnership interests was 104.15% of net asset values, up from 83.09% as recently as of Dec. 31.