Secondary PE Market Strengthens

Terry Flanagan

Expansion in the private equity secondary market is being driven by the expansion in the universe of sellers, changing regulations, and more active portfolio management, according to Anthony Tutrone, global head of Neuberger Berman Private Equity.

“On the secondary market side, this is going to be the fifth consecutive year of records,” Tutrone said at a briefing. “In the first half of 2013, there were $7 billion of transactions and it ended up $26 billion because a lot of the deals are at the end of the year. The first half of 2014 was $15 billion, and we think it’s going to hit $40 billion by year-end. That’s driven a lot by the regulations on financial institutions and the new capital requirements, so the banks in the US and Europe are going to continue to sell down.”

Private equity can continue to be an attractive asset class in 2015, with the potential to generate attractive return with low correlations to other investments, according to Tutrone.

As the private equity asset class continues to mature, one trend that is expected to continue in 2015 is the secondary market’s ability to provide liquidity for mature, end-of-life private equity funds, where partners desire liquidity but their interests aren’t aligned with those of the general partners.

“End-of-life private equity funds are using secondary buyers to create transactions that allow investors to get out who have been in it for a long time, and basically restart the clock on those funds, so we’ll see more of that,” Tutrone said.

With banks having to retrench on risk-based financing, private debt “in the form of second-lien and mezzanine is growing significantly,” Tutrone said. “It’s a great opportunity for private equity funds. The high-yield markets want very big liquid transactions, so transactions that are smaller are well-suited for this market, and investors can earn 400 to 600 basis points of additional interest rate by participating in the second lien and the ‘mezz’ loans.”

As for hedge funds, 2014 has been a lackluster year, driven by under-performance of small and mid-cap stocks where most hedge funds think they have their edge.

“The fact that US rates went down when they all thought they would go up” was an unpleasant surprise,” Tutrone said. “There was also a lot of memory on the hedge funds of 2008. They were worried about risks and probably the best way to play the market over the last five years is to ignore risk and just go long the market.”

Hedge fund inflows slowed dramatically in the second half of this year. Inflows since July have averaged $2.9 billion monthly, down from $13.8 billion monthly in the first half of 2014, according to BarclayHedge and TrimTabs Investment Research. The hedge fund industry lost 0.3% in October, improving on September’s loss of 1.3% but underperforming the S&P 500, which gained 2.4%.

Those who are “concerned about the overall levels of the market are going to want to look at long-short funds because they can participate in the upside but they can also insulate themselves on the downside,” Tutrone said. “I think correlations are going to be lower, so it’s going to play in the hands of good stock pickers and strategists on the hedge fund side.”

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