Secondaries Market Growth Underscores Role of Valuations
It’s not only limited partners scrutinizing valuations; regulators have also shown an interest amid the rise of the secondaries market and a growing propensity for GP-led transactions
By Robert A. Tribuiani, Managing Director, Head of Business Development, Murray Devine Valuation Advisors
For years, the secondaries market had been considered a small, sometimes-overlooked niche within private equity. After a year in which secondary investors amassed a record $74 billion of transaction volume, the momentum and growing impact of this “niche” can now be felt across the more expansive global PE landscape.
When the secondaries market first took root, the appeal was that it allowed investors to either sell limited partnership interests in existing funds or unload direct investments in companies within a captive portfolio. The upshot, of course, was that secondaries were able to offer liquidity in an otherwise illiquid asset class.
But as the secondaries market has grown in size, both limited partners and general partners are increasingly using the market to optimize their portfolio management. LPs, for instance, will use secondaries to continually refine their PE allocations, whether to minimize the J curve, improve diversification, or redeploy capital into newer funds with potential for more upside. GPs, alternatively, are turning to secondaries to effect restructurings in which existing LPs can exit a fund, knowing that new commitments bring additional capital and more time to fully realize remaining investments.
In a sense, secondaries have helped to further mainstream private equity and have brought a level of flexibility that appeals to both newer investors and most sophisticated LPs, alike. An unintended consequence, however, is that the growth of the secondaries market has also brought more scrutiny to valuations. This is particularly the case as GP-led transactions become more common.
As the proportion of GP-led secondaries have grown – by nearly a third year-over-year according to Greenhill & Co. – and the fact that they are becoming more common earlier in a funds life, the potential for conflicts of interest have investors and regulators scrutinizing valuations that much more closely. This should further dissuade GPs from attempting to smooth over any near-term volatility in their approach to valuation.
A recent Secondaries Investor article, for instance, highlighted some of the concerns raised by Oregon’s State Treasury in its annual private equity review. The pension noted that innovation in the secondaries market is translating into more complexity. Recaps involving more nascent partnerships can disrupt the alignment between GPs and LPs.
“While all of this has a place in a maturing private equity industry,” the pension noted, “the aggressive pace of innovation may suggest that secondary buyers have more appetite for deals than the current market can satisfy.” A corollary — one that brings to mind Ockham’s Razor – is that the innovation to accommodate this demand can also breed “complex and conflict-riddled transaction proposals,” the pension added.
That’s not to say that GP-led secondaries, on their own, are worthy of special attention or are in any way misleading. Still, many investors will use these transactions as an opportunity to revisit the mark-to-market valuations that usually serve as the basis for pricing secondary transactions.
Regulators, too, are paying close attention. Four years ago, just as GP-led secondary transactions were becoming more common, the SEC’s then director of the Office of Compliance Inspections and Examinations Marc Wyatt identified in a speech that the agency was indeed watching and addressing “issues such as zombie advisers and fund restructurings.” Since then, at least two GPs, in 2016 and last fall, have faced enforcement actions related to either valuations used in secondary transactions or potential conflicts that should have been disclosed.
By and large, though, the rise of the secondaries should be celebrated as an advance for the asset class. As the growth and increasing utility of the secondaries market continues in PE, so too does the transparency that aligns GP and LP interests. Ultimately, beyond providing confidence to investors and helping all constituencies manage risk, third-party independent valuations can also support ongoing growth of the secondaries market by imparting trust in the valuation that is helpful in navigating the added complexity.
Robert A. Tribuiani leads the overall business development efforts for Murray Devine Valuation Advisors. In this role, he is responsible for new business and works closely with the valuation client services team to support existing clients. Before joining Murray Devine, Rob worked as a senior business development executive for SolomonEdwards, a leading professional services firm headquartered in suburban Philadelphia and in similar roles for Longview Solutions and VerticalNet, both private equity backed companies. Rob is a graduate of Villanova University and earned a Bachelor of Science degree in Business Administration with a concentration in Finance.