Mega-fund secondary pricing begins to diverge

Pricing among similar-style US-based mega-funds raised during the credit bubble era of 2006 to 2008 has been widely diverging, with the average high bid on such funds sometimes varying by up to 20 percent of net asset values, according to secondary advisor Cogent Partners.

“Pricing differences have begun to emerge across funds as the underlying portfolio companies mature on differing trajectories and varying fund terms begin to impact funds’ projected returns and resulting secondary pricing,” Cogent said in its mid-year secondary pricing report, published this week.

Most large buyout funds that were heavily invested between 2006 and 2008 were carried below cost in 2009 and 2010 and frequently concentrated in “heavily levered” companies with challenged prospects, according to the firm. Pricing across these types of funds had been relatively stable when expressed as a percent of NAV, Cogent said.

The picture has changed, though, and the funds do not all look the same, Cogent said. “For those 2006-2008 funds that are performing well, there is a chance they may in fact earn carried interest. If so, the level of carry, fund waterfall and preferred return all begin to factor into secondary pricing,” the firm said. “These factors can create disparities in secondary pricing as a percent of NAV across otherwise comparably performing funds, which may not be immediately evident.”

For those 2006-2008 funds that are performing well, there is a chance they may in fact earn carried interest. If so, the level of carry, fund waterfall and preferred return all begin to factor into secondary pricing. Cogent Partners

There is a “reasonable chance” that discounts on these types of funds range from as little as 5 percent for top performers, to 25 percent and more for weak investment vehicles from the era, Cogent said.

General pricing

Pricing among buyout funds in general remains widely divergent, Cogent said. High quality assets have been in demand on the market – nearly 40 percent of the buyout funds in Cogent’s dataset in the first half of the year received an average high bid of 90 percent of NAV or more, the firm said.

At the same time, lower quality assets have been trading at heavy discounts. According to Cogent, more than 25 percent of the buyout funds it studies received an average high bid of less than 75 percent of NAV.

In general, the average high first round bid for buyout funds was 85 percent of NAV during the first half of the year, compared to 86 percent of NAV in the second half of 2011.

“Secondary pricing remained robust during the first half of 2012 despite meaningful volatility in the public equity markets and amidst continued concerns over the stability of the eurozone,” Todd Miller, managing director with Cogent, said in a statement. “Buyers seem to have acknowledged that volatility is the new norm, as the secondary market has been operating against the backdrop of pockets of global instability for quite a while, and pricing has remained relatively stable.”

‘Tail-end’ portfolios

Sellers in the first half of the year tended to be financial institutions from Europe and public pension systems in the US, the firm said. Global secondary market volume came in at around $13 billion in the first half of 2012, less than the record-setting $14 billion during the same period last year, but still on track for another unusually busy year on the market.

Sellers have a few common reasons these days for coming to the market, including reducing the number of

Todd Miller

relationships in their portfolios, moving from fund investing to direct investing and getting in line with new regulations. However, whatever their reason is for selling, “LPs are more regularly evaluating and actively managing their portfolios now than at any time in the past,” Cogent said.

Another interesting trend that has sprung up recently in the market is the sale of “tail-end portfolios”, or private equity holdings that are long past their original fund life.

In the first half of 2012, funds that were 2000 vintage or earlier comprised 26 percent of the funds Cogent marketed. The funds trade at big discounts, with average high bids in the first half of the year coming in at 76 percent of NAV. LPs who were not distressed and who had a hard time justifying taking such large discounts have begun using the market more often to get rid of such positions, the firm said.