Quality seconds

Today’s increasingly ubiquitous buzz-phrase for private equity enthusiasts is “opportunity in adversity”. It’s not the first time the phrase has been wheeled out, of course, but it shouldn’t be scorned just because of its lack of originality.

At a time when it can seem that wallowing in doom and gloom is almost obligatory, it is at least an upbeat sentiment – and one that Partners Group appears to have fully embraced. The Swiss alternative asset manager’s latest “Navigator” survey of industry trends, while making the obligatory nod to prevailing economic headwinds, nonetheless offers plenty of succour to life’s natural optimists – particularly with reference to the secondaries market. 

The survey doesn’t pull its punches in predicting that large cap buyouts with vintage years 2006/07 should be expecting to see NAV corrections of around 20-40 percent to the end of 2008. Even in the mid and small cap segment, the survey adds, write-downs of between 15-30 percent might be expected. However, “proper portfolio diversification” might bring this figure down to around 10-15 percent. But here’s where it gets good: while Partners Group acknowledges the prospect of further write-downs “of a similar magnitude” in 2009, it believes that the secondaries market offers a way to “substantially offset” these write-downs. 

What gives Partners Group this belief? “Distressed sellers” is the answer. Financial institutions with liquidity issues and long-established private equity investors with over-commitment strategies in particular have decided to dump unwanted private equity assets on the secondaries market in huge quantities. Partners Group reports that, in the fourth quarter of 2008 alone, volume in the global secondaries market reached more than $17.8 billion – compared with $30 billion in the whole of 2007. What is more, this is expected to be the “tip of the iceberg” as the credit crisis drags on and more institutions are forced to respond.

Volume is one thing, but the crucial point noted by Partners Group is the prices sellers are prepared to accept in order to shift these assets off their hands. The firm reports average discounts of 40-50 percent on defensive, high quality assets. The key for investors is to distinguish distressed sellers from distressed assets. Successfully identify the former and the secondaries market offers a great opportunity to buck the market.