Bank caution driving secondary market

Secondaries market activity has continued to grow through Q4 2011, driven by banks and insurance companies looking to offload private equity on their balance sheets before the year end..

Lars Lindqvist, founder of London-based secondaries broker Cattegatt Capital, told unquote" that the firm's deal flow has increased significantly during the second half of 2011, saying increased interest from institutions looking to sell their positions is a key factor in this, among others.

Banks and insurance companies are looking to strengthen their balance sheets to comply with capital requirements, according to Lindqvist. With so many institutions looking to offload their holdings before the year end, Q4 has presented opportunities in the secondaries market.

Secondly, discounted positions are also key factor behind the increased activity. Lindqvist says the level of discount relies on several factors, including GP pedigree , track record, vintage year, and fund strategy. "A strong GP with a classic strategy trades at below 10% discount. European buyout funds are typically trading between 5-20%". He adds, however, that it is difficult to generalise pricing due to the number of factors involved and that buyer's appetite may vary widely.

Regardless of the discounts however, placement agent Triago reported in its quarterly report that secondaries pricing remains strong, cushioned by falling NAVs. It contrasted private holdings with listed counterparts, controlling for certain valuation variables, to reveal a fairly modest 3-5% overall drop in private equity values. Secondaries pricing was estimated to follow a similar gradient, leading to little variability in discounts.

Secondaries broker Lindqvist agreed: "The spread hasn't widened," but highlighted that it has little effect on the secondaries interest seen at the moment. In comparison, he pointed out, private equity secondaries are trading at a smaller discount than others, such as those of hedge funds.

Lastly, Lindqvist says secondary investors anticipate the number of private equity-related exits will increase significantly in the next 18-24 months. He says many secondary investors are looking to escape the ‘J-curve,' and take up positions as funds reach their maximum level of returns.

Entering a mature private equity fund enables secondary stakeholders to reap higher returns, but this is reflected by the market: "Discounts are higher in the early stage of a fund and decrease with maturity."

While caution among banks stemming from the Eurozone crisis seems to be hampering deal activity in late 2011, the same phenomenon may be bolstering the secondary market as institutions move to offload riskier assets from their balance sheets.

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