How the secondaries market is offering investors a way out

They say good things come to those who wait. Yet waiting for the returns of a private equity investment can be painfully long. The average fund life is 13 years. For fund of funds it is even longer – around 15 years. And if investments prove troublesome they can stretch out much longer.

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Repackaged goods: Funds designed to invest in other funds are increasingly being sold off

To avoid investors’ money being tied up for eons, funds of fund and secondaries firms are increasingly selling off remnant fund stakes, allowing them to finally wrap up funds without having to wait for every single investment to be fully liquidated. The trend has been dubbed by some as ‘repackaged secondaries’.

A study by advisory firm Campbell Lutyens found that more than half of the 30 largest secondaries funds – funds that buy investments from other private equity firms – have sold on some of their own stakes.

About half of the 30 also said they had sold on parts of their own funds of funds. The value of these combined fund stake transactions increased by 21% to reach $ 1 billion in 2015, according to Campbell Lutyens.

Thomas Liaudet, a partner at Campbell Lutyens, said: “The maturity of the secondaries market has reached a stage where we see these types of transactions on a more frequent basis. It demonstrates that it works quite well.”

Time pressure

Ted Craig, a partner at MJ Hudson, suggested that some funds of funds and secondaries funds did not have enough fund years left to wait for the underlying value to materialise. “There is a NAV [net asset value] in these underlying funds and the issue for a fund of funds seller is that they can’t wait for that value to come out, because they are at the end of their fund life themselves.

“A secondaries fund that is in its investment period can buy these fund stakes at a discount and can easily wait two to three years for this value to materialise and make a return. It works well from everyone’s perspective.”

Richard Hope, a principal at Hamilton Lane, said these funds were not necessarily sold because the underlying assets were unattractive. “If it’s one person’s time to sell, that doesn’t necessarily mean that there is no value in these portfolios.”

London-based fund of funds manager Pantheon has sold several of its older fund portfolios. Francesco di Valmarana, a partner at Pantheon, said many of the large funds of funds and secondaries funds had done this with older vehicles dating back to the mid-1990s.

He said: “You don’t want to write them off but you still have to monitor and report on the funds. By selling them, you reduce the costs of looking after the fund. Because these portfolios are generally small, it won’t have a meaningful impact on the overall performance of the fund.”

Such sell-offs have an impact on the two metrics most often used to measure private equity performance – the internal rate of return and the exit multiple. Internal rate of return calculations are based on how long an investment is held, and they in particular can be helped by selling off a stake rather than holding it for an extended period.

Hope said: “We are focused on the net IRR and other investors are also increasingly [using this metric]. As the market continues to grow, I suspect these tail-end deals will increase as well.”

Investor caution

Nevertheless, some investors are cautious about these repackaged secondaries. Jos van Gisbergen, senior portfolio manager at Syntrus Achmea, said firms were under more pressure from investors to close some of these older funds, but questioned whether there would be any underlying value in these older vehicles. “Some niche specialist players [in the secondaries market] are buying up these tail-end funds in the hope it will yield some earnings. But if you haven’t been able to sell [these assets] within eight to 10 years, will it really happen in the coming years?”

He added that, in 10 years’ time, the buyers of these older funds might face the same problems and might end up unable to sell parts of their portfolio.

Christiaan de Lint, founder of secondaries firm Headway Capital, said that the remaining fund stakes in older fund of funds vehicles were usually those containing assets that were “less easy to sell and are perhaps of lower quality”. He said: “These need to be priced carefully and analysis is very important in these deals. You can buy at a 30% discount and still get a bad deal if you don’t know exactly the real value of the underlying assets.”

Perhaps that is why many firms are keen to offload these repackaged portfolios, but not necessarily eager to buy them. Pantheon had not been an active buyer in this area, di Valmarana said. “You either have to buy at a large discount or you have to put in structuring or leverage to make a decent return on these deals.”

Adam Howarth, global co-head of private equity secondaries team at Partners Group, said the firm did not spend “a lot of time” looking at these deals even though 10% of the deals it looked at in 2015 fell into this repackaged secondaries category.

During a panel session at the SuperReturn conference in Berlin in February, Pål Ristvedt, a partner at secondaries giant Lexington Partners, expressed concerns about repackaged secondaries.

”We frankly struggle with them, because if you are a carry-driven institution, which I think most of us are on this panel, you are going to need some multiples. And these deals in tail-end transactions generally don’t have a lot of multiple. What they do have is a good IRR.”

In order to get a return on these deals, you could use leverage to amplify returns to earn carried interest, he said, but suggested that most of these portfolios with real underlying value had already been sold.

“You’ve got to ask yourself: how much liquidity has been coming out of the market, in particular from the 2006, 2007 vintages in the last 12 months? What is really left in these portfolios and how well do you know these portfolios? You have to either know them extremely well or be extremely confident that the one or two companies that are left inside each fund is indeed going to come out and give you the IRR [you need].”


According to Liaudet, there are several reasons why the technique has picked up recently: “Market timing is one reason; it is a good time to sell.”

Di Valmarana agreed. “Five years ago, pricing was such that people wouldn’t sell these tail-end portfolios, but pricing has become much more aggressive and sellers have been able to take advantage of this.”

Another reason is that the market for second-hand fund stakes is becoming more mature, Liaudet said. “There’s also a lead-by-example trend, whereby some of these firms are doing it, so others are copying it.”

De Lint said: “I would argue that these older funds still need solutions. These funds can’t be extended forever, so we will still see these deals happening, but it is never going to be a huge part of the secondaries market.

He added: “I once came across an older portfolio for which the auditing costs for one year were equivalent to half the value of the actual portfolio, so it made sense to sell them to save costs and therefore pricing wasn’t the main driver. These deals allow investors to clean up old investments, at a price level where there could be value for buyers.”

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