Looking For A Sure Thing? Secondary Funds Come To Mind

Ask limited partners what manner of funds they have an appetite for and the answer often includes secondary funds. And no wonder.

Secondary funds offer instant diversification by vintage year. They provide early distributions in an industry often parched for liquidity. They can provide access to invitation-only funds. And, while arguably taking less risk than other private equity funds, they appear to provide superior returns.

Consider our database of 38 secondary funds, vintage years 1990 to 2006, collected from 13 institutional investors that make their return data public (with data for most of the funds current through March 31 2011). Incredibly, only one fund in the entire database had lost money for investors—a 2004 vintage fund that, unlike most of the partnerships in our database, pursues a strategy of buying interests in portfolio companies, not funds. And it hasn’t lost much, on paper anyway. As of June 30, this particular fund, W Capital Partners I LP, was showing a 1x investment multiple, and a negative 1.8 percent net IRR, for backer California Public Employees’ Retirement System. (By contrast, its successor 2007 fund, whose strategy migrated away from venture capital, is doing great, having generated a 1.6x investment multiple and 21 percent net IRR as of June 30.)

All told, the 37 funds that provide relevant data have drawn down $2.7 billion, returned $2.7 billion, and have remaining holdings valued at $1.1 billion. That’s good for a total investment multiple of 1.42x. The bottom-quartile investment multiple for the 37 funds is 1.16x; median 1.30x; and top-quartile 1.51x. That may not sound over-the-top terrific. But bear in mind secondary funds tend to return money to their investors much sooner than do regular private equity funds. And that fact shows up in the high IRRs they generate. The bottom-quartile IRR for our sample of 31 secondary funds that provide IRRs is 6.05 percent, median 14.10 percent and top-quartile a lofty 27.62 percent. For comparison, the bottom-quartile IRR for all 518 buyout and corporate finance funds in our database is 3.18 percent, median is 9.93 percent and top-quartile is 18.78 percent (for the most part as of March 31, 2011).

Below are the top 10 performing funds in our secondary database by investment multiple, or roughly the top quartile of funds that we have investment multiples for.

[slideshow]

[slide title="10. Landmark Equity Partners IV L.P"]

Vintage Year: 1994

Investor: Pennsylvania PSERS

Commitment: $10.5 million

Investment Multiple: 1.51

IRR: 108.21%

[slide title="9. Paul Capital Partners VII"]

Vintage Year: 2001

Investor: Canadian Pension Plan

Commitment: $90 million

Investment Multiple: 1.59

IRR: n/a

[slide title="8. DLJ STrategic Partners"]

Vintage Year: 2001

Investor: Pennsylvania PSERS

Commitment: $200 million

Investment Multiple: 1.59

IRR: 17.16%

[slide title="7. Lexington Capital Partners V LP"]

Vintage Year: 2002

Investor: CalPERS

Commitment: $50 million

Investment Multiple: 1.60

IRR: 20.60%

[slide title="6. Lexington Capital Parnters IV LP"]

Vintage Year: 2000

Investor: CalPERS

Commitment: $100 million

Investment Multiple: 1.80

IRR: 19.60%

[slide title="5. CSFB Strategic Partners II LP"]

Vintage Year: 2003

Investor: Pennsylvania PSERS

Commitment: $300 million

Investment Multiple: 1.80

IRR: 35.30%

[slide title="4 VPAF II LP (Adams Street Partners"]

Vintage Year: 1990

Investor: Montana Board of Investments

Commitment: $4 million

Investment Multiple: 1.97

IRR: 25.26%

[slide title="3. CPP Investment Board - Paul Capital Holdings"]

Vintage Year: 2002

Investor: Canada Pension Plan

Commitment: $81 million

Investment Multiple: 2.18

IRR: n/a

[slide title="2. CPP Investment Board - Paul Capital Holdings II"]

Vintage Year: 2004

Investor: Canada Pension Plan

Commitment: $120 million

Investment Multiple: 2.25

IRR: n/a

[slide title="1. Brinson Venture Partnership Fund III (Adams Street Partners"]

Vintage Year: 1993

Investor: Montana Board of Investments

Commitment: $5 million

Investment Multiple: 3.12

IRR: 29.64%

[/slideshow]

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