Secondary Market: Trends & Takeaways in GP and LP Markets
What are the biggest trends and takeaways we’re seeing in the GP and LP markets?
LP Market
This one is simple for us. It’s really the reemergence of motivated sellers and their ability to transact directly with secondary buyers and buyers in the market that can offer speed and certainty in a very uncertain environment. This means that the quality of funds being sold is much higher today than it was a year ago. Think of the pricing and how that might play into this. Lower-quality funds, funds that might have underperformed or funds where the general partner quality is lower, used to price at modest discounts. Today those are going to price at material discounts. If you have a portfolio with a mix of assets, we believe buyers today are gravitating towards buying the highest-quality funds, very much cherry picking those funds at a modest discount, which we think is very interesting in this market.
We think it also allows the buyer to focus on the micro in the fund. You have more conviction in the GP. You can do more diligence on the underlying assets, the operating performance, the exits, the path to exits and valuation. For a market that needs to build conviction in order to buy something, we think this is really helpful in this environment.
GP Market
On the GP side, there are lots of trends. There are two that are really noteworthy. One, over the past few years, we believe GPs have become much more active and much more influential in secondaries, obviously in the GP-led market, but also in the LP-interest market. We have seen GPs, for example, introduce us proactively to some of their non-core LPs because GPs know that eventually those LPs will sell their interest. This didn’t really happen in any sort of scale five, 10 years ago and it’s happening more and more today. GPs recognize that primaries, co-investments, secondaries – all the investment worlds are colliding, and GPs recognize that they can use the secondary market to build relationships with the LPs to whom they want to get closer.
We’re also beginning to see an uptick in LP tender offers being discussed, being contemplated and ultimately being launched by GPs. This isn’t a big chunk of the market, but it has entered many conversations recently and if you think about it, it makes sense. A lot of GPs are fundraising. A lot of LPs are overallocated to private equity and they’re cutting back on commitment size of relationships. LP tenders allow GPs to give non-core LPs liquidity and even allow core LPs to free up capital to commit to the GP’s next fund. And that’s what they want. Of course, the tenders usually come with the stability into the GP’s next fund. As fundraising becomes more difficult, given the LP overallocation issue, we do expect to see more of these LP tenders, so we’ll see if this trend materializes.
The projections published herein are based on a regression of quarterly public market index returns against quarterly private market index returns. This regression generates an alpha and a beta by strategy which can be used as inputs into the single-index model of pricing assets (Sharpe 1964, Lintner 1965). The formula for the single-index model is:
rPrivate Markets = αPrivate Markets + βPrivate Markets (rPublic Markets –rRisk Free )+ rRisk Free
Where:
rPrivate Markets = Return of Private Markets
rPublic Markets = Return of Public Markets
αPrivate Markets = Alpha of Private Markets
βPrivate Markets = Beta of Private Markets
rRisk Free = Risk Free Rate
The regression formulas for Core and Non-Core Real Estate differ slightly from the single-index model in that the regressions are multi-index models, which include multiple betas and public market returns to better predict private market returns, such as the U.S. Regression Indicator Index.
Once all inputs are obtained, we create a 75% confidence interval for our expected returns. This should denote the inherent uncertainty in these sorts of predictions. In general, we expect to be accurate within a 400 basis point spread with 75% confidence in quarters of normal stock market volatility. During periods of outsized positive or negative returns in the public markets, we would expect to either be less accurate or for the confidence interval to expand meaningfully. We also expect individual portfolios to vary meaningfully from these projections, as individual portfolio returns vary from the industry’s returns for many reasons, including concentration of assets, different investment pacing, and different strategy/geography makeups, to name a few. Larger and more mature portfolios should be expected to have a performance more similar to the market, and therefore more reflective of these estimates, than other portfolios might be.
To estimate the next quarter’s valuation for a portfolio, you can apply the estimated quarterly growth rate associated with it. The quarterly growth rate should be applied after adjusting for all fund contributions and distributions made during the quarter, in accordance with the Simple-Dietz methodology for calculating returns. Note that all calculations shown in the document are in USD. Therefore, the formula for calculating rPrivate Markets shown above yields a return in USD. To apply the rPrivate Markets to a portfolio with valuation and cash flow information already in USD, use the formula below:
Predicted NAVEnding=(NAVBeginning)(1+rPrivate Markets)+ ((1+rPrivate Markets)/2)(Period Capital Calls–Period Distributions)
If the portfolio valuation and cash flow information is not in USD OR you wish to convert a USD return to a non-USD currency, an “FX Effect” factor must be applied. The formula should be adjusted as shown below:
Predicted NAVEnding=(NAVBeginning)(1+rPrivate Markets+FX Effect)+ (1+(rPrivate Markets+FX Effect)/2)(Period Capital Calls–Period Distributions)
Strategy Definitions:
Credit: This strategy focuses on providing debt capital.
EU Buyout: Any buyout fund primarily investing in the European Union.
Mega/Large Buyout: Any buyout fund larger than a certain fund size that depends on the vintage year.
Real Estate: Any closed-end fund that primarily invests in non-core real estate, excluding separate accounts and joint ventures.
SMID Buyout: Any buyout fund smaller than a certain fund size, dependent on vintage year.
VC/Growth: Includes all funds with a strategy of venture capital or growth equity.
Index Definitions:
MSCI Europe Index: The MSCI Europe Index tracks large and mid-cap equity performance across 15 developed market countries in Europe.
MSCI World Index: The MSCI World Index tracks large and mid-cap equity performance in developed market countries.
S&P 500 Index: The S&P 500 Index tracks 500 largest companies based on market capitalization of companies listed on NYSE or NASDAQ.
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There are a number of factors that can affect the private markets which can have a substantial impact on the results included in this analysis. There is no guarantee that this analysis will accurately reflect actual results which may differ materially. These valuations do not necessarily reflect current values in light of market disruptions and volatility experienced in the fourth quarter of 2020, particularly in relation to the evolving impact of COVID-19, which is affecting markets globally.
The information contained in this presentation may include forward-looking statements. Forward-looking statements include a number of risks, uncertainties and other factors beyond our control which may result in material differences in actual results, performance or other expectations. The opinions, estimates and analyses reflect our current judgment, which may change in the future.
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As of October 5, 2022