This interview, part of Clear Path Analysis’ series of one-to-one discussions with leading North American based asset allocators, economists and politicians, focuses on trends in the private equity secondary market. Issues covered include, why the private equity secondary market has become such an appealing asset class to institutional investors, if LPs feel the effects of the complexities involved in transferring private equity assets, if terms for buyers in the secondary market differ much than in the primary market, if the meteoric rise in asset values is happening across the board, plus what are some of the factors behind valuations being so high?

David Grana: What are your general thoughts about the private equity market?

Donald Pierce: It is fair to say that, broadly speaking, we are finding assets to be priced higher. Time will tell whether or not the growth that many managers expect does, in fact, come through. But it is important to point out that uncertainty is what makes all markets.

David: Why has the private equity secondary market become such an appealing asset class to institutional investors?

Donald: The industry itself talks about this, however, for newer investors who are looking to kick off their private equity exposure, it is a great way to immediately get a diversified portfolio of different vintages and approaches. It has a nice feature related to getting your programs off the ground. The way that more experienced investors look at it is that they can often purchase things that are either at a discount or use it to get to those harder to access managers, if for whatever reason a firm decides to sell. The industry talks about the ways to access the market, and the secondary market offers a compelling way to get a look at existing portfolios and the value of these portfolios.

David: Do LPs feel the effects of the complexities involved in transferring private equity assets from one party to another, or is it the general partners (GPs) that bear the brunt of the transactional details?

Donald: By in large, it is relatively seamless to the asset owners. There is no doubt that lots of paper work gets exchanged, but asset owners do not see any of this until it is finalized.

David: Do terms for buyers in the secondary market differ much than in the primary market and how so? Are they more or less favourable?

Donald: When you become an LP in an older vintage, you are effectively agreeing to the contract terms that were in place at that time. There are ways to get around that, but for the most part, if you enter into a 2006 structure, the GP will probably have more favorable terms and conditions than a 2011 vintage structure. This isn’t to say that you should only invest in a 2011 vintage over a 2006, but it does raise an interesting nuance that you have the ability to enter into a contract that is older, but with more favorable terms to the GP.

David: We have seen a meteoric rise in asset values all across the board, are we seeing the same thing with private equity in the secondary markets?

Donald: I am afraid so. It has been great for our existing portfolios, but it plays havoc on deploying new capital.

David: What are some of the factors behind valuations across the board being so high?

Donald: The trick is that in any other world, you might call this inflationary. The definition of inflation is too much money chasing too few goods. If you have a limited supply and a lot more money chasing it, it certainly seems that financial assets and their private asset brethren are definitely bid up as a class. That said, there are individual assets that are interesting and may be well priced. It tends to be idiosyncratic and broad-based, whereas, in early 2015-16, you might have found the energy asset class to be more interestingly priced after the sell-off in the oil markets.

David: Are there specific industries or sectors that are demonstrating better value than others?

Donald: We are finding interesting areas within emerging markets, but this is less in the private equity space and more in emerging market debt. In the private space, very little of it is not bid up already.

David: Are there certain sectors that you see being traded more on the secondary markets over others?

Donald: It is perhaps not surprising that the bulk of the fundraising and secondary opportunities are the same – that would be the buy-out space. I haven’t seen a bigger flow of energy secondaries. That is not to say that they aren’t there, but I haven’t seen a large pick-up in that space.Broadly speaking, the secondary sellers tend to use this more for portfolio management and relationship management, as opposed to trying to divest themselves from a particular sector.

David: Are there certain nuances to this asset class that we don’t see in others?

Donald: One of the factors that reinforces the elevated nature of the asset class, which we have seen proposed more often, are GPs potentially holding out for stapled transactions. In other words, they will let you make a secondary market purchase if you commit to their future funds. Although I haven’t seen a lot, and I don’t know if these deals get inked or not.

David: Thank you for sharing your views on this subject.

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