While waiting to assess the full effects of Q2 lockdowns on NAVs, buyers and sellers alike are taking a prudent approach
While waiting to assess the full effects of Q2 lockdowns on NAVs, buyers and sellers alike are taking a prudent approach
Like the primary fundraising market, the secondary market has seen something of a pause in the last few months, as investors considered how to respond to the effects of COVID-19, assessed their liquidity, and reflected on the likely valuation impact of current economic developments.
Secondary investors are starting to emerge from the ‘wait-and-see’ mode they had been in due to the significant disparity in valuation approaches that different private equity managers had taken for Q1 marks. Since the Western world spent only a few weeks of Q1 in lockdown, there was scope for some managers to choose to present Q1 valuations that incorporated minimal COVID-related discounting. In contrast, other managers took account of the significant movement in sale volumes during the last two weeks of the quarter and the public market multiples as of 31 March in order to take the ‘full hit’ in Q1, resulting in a significant discount to the Q4 position.
Nonetheless, with Q2 developments becoming clearer, some groups have sought an ‘early-mover’ advantage by launching processes ahead of a broader expected resurgence from August onwards, when Q2 marks are available.
Investor appetite to purchase portfolios at or near NAV depends in part on the perception of how accurate NAV is: with such a wide dispersion of NAV calculation approaches, investors are understandably circumspect. Investors are uncertain whether managers have taken the full hit from COVID-19 in their Q1 stated NAVs. Given that private market valuations tend to lag those of public markets, it is understandable that investors are being careful. While public markets remain volatile, in a fractious and unstable macroeconomic and macropolitical environment caution is still the watchword for most.
- For buyout strategies, we have seen Q1 valuations ranging from a small uplift to Q4 through to a 38% discount, with an average discount of 11% across funds
- The spread for private credit has been narrower, but with a similar 10% average discount
- Real assets funds have typically weathered the storm a little better, with an average 4% discount
- Secondaries funds will generally lag in valuation impact by about one additional quarter
Sellers are aware that the above factors have created some reticence on the part of buyers, and as such there has been a reluctance to launch any but the most critical and urgent secondary processes. In those that have been launched, there has been some difficulty in finding a clearing price due to a mismatch in buyer/seller expectations and uncertainty regarding the robustness of stated NAVs. Additionally, many secondary transactions that were signed in the first quarter of the year have been pulled, with buyers triggering Material Adverse Change clauses in order to walk away or renegotiate deals that had been agreed prior to the pandemic.
At the same time, the secondary industry is flush with dry powder (c.$150bn in dedicated secondaries funds) but is showing caution currently. We expect many buyers are waiting for seller pricing expectations to adjust before deploying into the market. Secondary investors in this market are likely to be highly selective and value oriented, with a particular focus on downside protection and structured investments, as well as late primary/early secondary situations. While secondary activity in Q2 has focused around rescue financing, annex funds, and distressed sellers, in Q3 we expect a flight-to-quality approach to deploying capital this year, with more processes focused on accretive follow-on funding or high-quality single-asset continuation vehicles.
Looking ahead, the Credit Suisse Private Fund Group has remained in contact with numerous secondary investors across the market, and has found a widespread expectation that the market will pick up again later this year. The overwhelming majority of those we have spoken to forecast that secondary activity will rebound in Q3. We suspect that the critical factor will be the widespread release of Q2 NAVs, in c. mid-August, which will reflect an entire quarter of lockdown in the Western world and therefore fully price in the effects of COVID-19 that have not universally been captured in Q1 results. We would note that stark recoveries in the valuations of publicly listed private equity vehicles since 31 March may indicate that secondary market discounts could be limited for portfolios that have fully accounted for the valuation effects of COVID-19.
In the meantime, while we have not seen the ‘firesale’ secondary trades that took place during the Global Financial Crisis, certain capital-constrained LPs are exploring liquidity options as they approach allocation limits alongside slowing distributions. Many LPs are keen to ensure that they have sufficient capital available to give full allocations to 2020/2021 vintages, so as not to miss out on vintages that some suspect may have return signatures similar to the high-performing vintages of 2008/2009. We suspect that such sales are more likely to take place later in the year when pricing has stabilized, except in cases where LPs face significant liquidity stress, where accessing the ballooning preferred equity market is likely to be a more attractive alternative to a sale at a discount.
In aggregate, we believe that the reaction of the secondary market to COVID-19 has been prudent and measured. Sales that were agreed at prices that can no longer be justified have been pulled or, in some cases, renegotiated; there has not been widespread panic selling, and the general approach of both buyers and sellers has been cautious. As stability returns to the wider public markets and primary private markets, we expect secondary activity to rebound strongly, driven in particular by GP-led opportunities that have been crystallized by the delay in the M&A and IPO exit pipeline.
About Credit Suisse Private Fund Group (PFG)
The PFG is one of the largest and most experienced global private capital advisory firms in the industry, having raised over $570bn of capital for over 400 funds since 1994.
The group has a global team, with locally based professionals in New York, London, Hong Kong, Chicago, San Francisco, Dallas, Santiago, Tokyo, Sydney and Seoul.
The PFG’s Capital Solutions team provides customized solutions, utilizing a variety of transaction structures and has advised on c.$46bn of secondary, direct, and co-investment transaction volume. The team’s expertise encompasses the full spectrum of alternative assets, including private equity, real estate, hedge funds, venture capital, mezzanine/credit, infrastructure and direct asset portfolios.
For more expert insights on the secondary market, read Preqin's H1 2020 Secondary Market Update.