Pension funds selling on the secondary market may need to curb their expectations, Shayla Walmsley warns.
Two reports published this week claim to be seeing massive increase in investors offloading fund investments onto the secondary market. The problem? Finding buyers for them.
One of the reports, from Landmark Partners, reckons the market last year touched $2.6bn (€1.9bn), from 48 transactions, excluding private deals between fund investors and those under $10m in European non-listed funds.
That growth is the result of a change in the nature of the sellers. Five years ago, the sellers comprised investors in distress including, in the US, 'Yale model' institutions over-allocated to non-performing alternatives. Now at least 30% of the market is coming from pension funds motivated by market volatility to migrate their capital to core investments as part of a de-risking exercise.
"Pension funds are looking at where their exposure is – whether they really want to be in a pan-European regional fund or whether they'd prefer to be in a country or sector-specific fund with a manager who has 25 years' experience," says Paul Parker, real estate managing director for Europe and Asia at Landmark Partners.
The problem is the potential lack of buyers for what are often assets made difficult by leverage, underlying valuations and cash flow projections. The number of specialist buyers is unlikely to increase. "We're not alone," says Parker. But he is not exactly operating in a crowded market, either. Non-real estate private equity firms will struggle to enter secondaries because the "totally different" small and medium-sized fund market would necessitate building new in-house capacity, says Marc Weiss, head of private real estate secondaries at Partners Group, which produced the other report.
Few new obvious buyers are coming into the market. A couple of managers, such as AXA Real Estate and Morgan Stanley Alternative Investment Partners, have launched secondary funds. But at least in Morgan Stanley's case, it is looking at small portfolios of 10 or 15 assets, not amorphous portfolios – even if diversification with the acquisition of in some cases hundreds of assets is one of the benefits of investing in the secondary market.
Not that other good reasons to buy are absent. Secondaries mitigate the J-curve (in contrast to investing in a blind-pool fund) and create potentially value-added returns for core risk. As Weiss points out, previously value-added assets, once they come onto the secondary market, look more like core because, by that time, the work has been done on them.
"Sellers look at the risk profile for the underlying fund at the time they made the investment, whereas we look at it from the perspective of what assets we are buying at the time we buy it," he says.
In contrast, if you buy into mature portfolios, "the value creation endeavours are mostly complete, so what may have been value-added or opportunistic at the outset is likely to be more core-like at the time we buy it".
The problem is not that there are not good reasons to buy, but rather that those offloading them are reluctant to accept sufficiently attractive discounts.
There are ways around it. Cherry picking is one. But left over will be a hulking overhang of secondary secondaries sellable only at significant discounts, including most of the pre-crisis, excessively leveraged, investment bank-sponsored funds. Nor will sellers necessarily be prepared to take the hit, especially given their reluctance to accept buyers' existing pricing expectations.
Everything has a price, says Parker – and not just in the secondary market. Expectations have moderated somewhat, says Partners Group, with the discount to NAV on non-core having dropped to, on average, 10-25% from its post-crisis peak of 50%. It is that adjustment that in part accounts for the spike in transactions.
Still, there are questions to be asked about the market's ability to absorb the newly available assets. "It is true that there are some funds for which there is no secondary market and that, for these funds, sellers will likely have to hold to maturity and hope for the best," says Weiss.