New Investment Trends are Recalibrating the PE Industry, Say Expert Panelists

Limited partners are pursuing niche strategies and driving new investment trends that are impacting overall LP allocations and middle-market private equity, a panel of experts told investors attending the 2014 Michigan Private Equity Conference on Oct. 17.

One of the headline-grabbers is the emergence and rapid growth of the private equity secondary market, which focuses on the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds. To meet burgeoning demand, many mainstream private equity and global investment advisory firms have set up specialized teams or programs dedicated to the origination, structuring, execution and monitoring of secondary transactions in the private equity and hedge fund markets.

“When I joined Blackstone, we were seeing $2 billion to $3 billion of transaction volume in secondaries,” said Brian Kolin, a director in the Strategic Partners Group, Blackstone’s secondary private fund-of-funds business, which was acquired from Credit Suisse in August 2013. “Deal flow rose to nearly $20 billion in 2008 and then dropped off to approximately $6 billion to $9 billion during the recession. Now we are seeing very nice growth. The volume in secondaries hit $28 billion in 2013. In the first half of 2014, it was up to $16 billion.”

“Secondary investment has evolved and is now its own asset class,” said Jeremy Duksin, a senior member of Credit Suisse Private Fund Group’s secondary advisory team. “In the past, secondaries were viewed as a distressed asset, where PE firms were looking for liquidity. Now, secondary investment has become a direct strategy where PE firms are seeking to buy out minority investors’ stakes.”

The panelists identified several factors that are fueling the momentum and maturation of the secondary market. On the supply side:

  • New regulations and tighter oversight in the U.S. and Europe are compelling banks, funds, insurers and other institutions to pare down or sell off assets.
  • Impatient limited partners are opting to sell their interests in PE funds early to receive liquidity for their funded investments as well as a release from any remaining unfunded obligations.
  • General partners with funds that have become elongated are selling assets to salvage value, achieve liquidity for investors, clean up portfolio holdings and ease administrative burdens.

On the demand side:

  • Institutional investors and dedicated firms are looking at secondaries as a more efficient way to gain increased exposure to diversified PE portfolios with a shorter investment period, usually 3 to 4 years.
  • General partners raising new funds are initiating stapled secondaries, where a secondary buyer purchases an interest in an existing fund from a current investor and then makes a new commitment to the new fund being raised by the GP.

“It’s hard to lose money in the secondary market, but you’re not getting the home runs,” Kolin said.

Two other niche plays by institutional investors ─ co-investment and direct investment ─ are shaking up the alternative investment industry, the panelists said. Sid Murdeshwar, a vice president of the Co-Investment team at AlpInvest Partners, reported he is enhancing total returns by co-investing alongside some of the best and brightest minds in private equity and cherry-picking assets. Institutional investors who co-invest also benefit from low-or-no-fee structures and the opportunity to dial up, at a low cost, on potentially high-return investments made by PE fund managers. “We also get to see how the sausage is made, so to speak, and where the sponsor fits within our deal flow,” Murdeshwar remarked.

Increasingly, major investors such as Singapore’s sovereign-wealth vehicle GIC Pte. Ltd. and large pension funds such as the Canada Pension Plan Investment Board are making direct investment in companies and infrastructure projects. Many have hired their own advisory teams and going head-to-head against private equity firms for deals in the primary and secondary investment space. Whether this trend will continue is uncertain.

“We’ve seen more direct investment recently, but we use a sponsor-driven model to do primary and secondary investments,” Murdeshwar said. “We don’t want to compete against the folks we are co-investing with. And we just don’t have the staff for direct investment.”

“The large Canadian LPs are talking about it, but I don’t know whether other LPs have the capacity to compete in direct investment,” Duksin remarked. “Outside of the major sovereign-wealth organizations, I don’t believe it will show up [on the radar].”

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