Data from eFront, a provider of alternative investment management software and solutions, shows that since the start of 2013, distributions from private equity secondaries funds globally have risen steadily to a record level. At the same time, capital calls have fallen to a historic low.
eFront cites multiple theoretical factors in support of private equity secondaries investments, but chief among them is often the shorter time to liquidity delivered by the asset class, as a result of the investments being made in mature portfolios. However, since 2013, an unprecedented shift has taken place in the relationship between capital calls and distributions, meaning this may no longer be the case.
From 2000 to 2012, capital calls were significant. On a yearly basis, funds would call on average 14.6 per cent (Fig.1). However, since 2013, calls have fallen steadily, from 8.73 per cent in 2013 to just 1.08 per cent in 2017 – the lowest level on record.
Not only have funds reduced their capital calls, but distributions have increased significantly, reaching more than 17 per cent in 2017 – their highest level on record. From 2013 onwards, distributions have outpaced capital calls for five straight years, meaning that on a net basis, secondary funds no longer support the thesis of offering significant upfront net capital deployment.
On the returns side, secondaries funds on aggregate generate significant multiples of invested capital. Since inception, European funds have recorded a return (TVPI) of 1.53x, while North American funds have generated a 1.52x. If European funds appear as more attractive, they nevertheless exhibit a wider dispersion of returns. Top quartile funds reach a 1.65x and bottom quartile funds a 1.09x multiple. As a matter of comparison, the figures are respectively 1.56x and 1.31x for North American secondary funds.
Although attractive, these multiples fall short of the performance of LBO funds, which sit at 1.61x in Europe and 1.55x in North America.
Comparing the selection risk regardless of the geographical focus of funds shows that the TVPI spread between the top and bottom quartile performers investing into secondaries is 0.36x, while the same is found to be 0.71x for the LBO funds. The lower selection risk can be explained by the fact that the investors into secondaries know more about what they are buying, as the stakes for sale are in active private equity funds already invested.
Tarek Chouman, CEO of eFront, says: “Secondaries funds can match some of the expectations of investors. However, this is far from a systematic outcome and investors have to be aware that there is a trade-off: getting more information and relatively faster returns translates into lower absolute returns and lower absolute net exposure, which results in lower selection risk for the secondary funds relative to the LBO funds. The positive news is that secondary funds provide investors with differentiated investment instruments. They are therefore potentially very valuable.”