Special Commentary

Window of opportunity

The 2022 bear market in stocks and bonds had many large institutional investors pulling back on adding to private equity (PE) allocations.

Context: As investors’ stock and bond values have fallen, for many their percentage of private holdings – whose values have generally been more stable – has swelled beyond investment policy ranges. To bring portfolio allocations back to targets, these affected pensions, foundations, and insurance companies reassessed their new PE commitment volumes in 2022.

• This is a forced short-term pause by some institutional investors that typically have access to the most attractive deals.

More opportunities in the private markets are becoming available to high-net-worth individuals and smaller institutions as private funds’ general partners (GPs) have been forced to accommodate a broader range of investors (limited partners – or LPs).

Secondary market opportunities in the spotlight

The secondaries strategy within private equity will play a pivotal role against the backdrop of a dry IPO and rigid acquisition environment. Attention in this area has significantly increased as the public equity and bond market sell-off begins to take a toll on allocation targets and cash reserves.

• 52% of investors surveyed saw secondaries as an attractive investment opportunity, compared to only 21% last year.

Potential repeat of ’20 deal flow for private investment buyers and sellers

A key secondary market driver is limited partners looking to rebalance their portfolios because their private equity allocation percentage has increased. One of the main market detractors is large GPs trading among themselves during this weak exit environment.

• Tactical rebalancing is also underway as some investors offload LP interests in preparation for a forecasted recession and coinciding private market correction.
• Forfeited interests from cash-strapped limited partners is another avenue for secondaries managers to purchase stakes at a significant markdown.

As noted, the stage is set for timely secondaries vintages to deploy capital quickly and deliver favorable returns when regular deal flow resumes. The current conditions have several parallels to the 2020 COVID disruption.

However, many skeptics are concerned about a backlog of private portfolio holdings being widely mispriced which would negatively impact long-term returns.

• The counter to this observation is the thorough diligence and modelling during pre-transaction deal valuation which is often linked to public market peer multiples and includes liquidity discounts of 20-30% or more.
• Asset acquirers in the secondary market lean on superior negotiation skills and deal terms to differentiate their strategies from competitors and deliver return on investment (ROI).

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