As secondary volume slows, LPs ask the important question: why sell?

Here’s the issue for the secondary market: The market is flooded with unspent capital raised over the past few years, but if an LP sells, where does he or she put the proceeds?

In today’s low-interest-rate environment, few attractive areas to place capital can produce the potential returns of private equity.

And these days, after several years of record PE-fund distributions outpacing capital calls, many institutional investors find themselves under-allocated to the asset class. Selling simply digs an LP deeper into an under-allocation hole.

So the question becomes, why sell? This is what LPs have to consider when thinking about the secondary market, and this calculation is helping slow activity in secondaries, sources told Buyouts in recent interviews.

The market, which has hummed along at record activity levels for the past few years, is slowing. That’s according to two major industry surveys, from Greenhill Cogent and Evercore, both of which show first-half deal volume down from the year-earlier period.

Evercore’s report, published this week, showed secondary volume totaled $17 billion, down 17 percent from a year earlier. Greenhill Cogent in July found first-half volume reached $12 billion, the lowest first-half level since 2013.

Cogent said part of the slowdown involves a dearth of $1-billion-plus deals. The first half saw only two such deals, the firm said.

Cogent found that traditional LP-stake sales represented almost 70 percent of first-half volume, with GP-led deals like restructurings, directs, spinouts and tender offers accounting for the balance.

Volume in the first half was affected by shocks including low oil prices, volatile public markets early in the year, and the British vote to exit the European Union.

“The macro volatility impacted the secondary market by fostering uncertainty regarding asset values and near- to medium-term exit environments and created the desire to wait and see how the macro environment would impact March and/or June” net asset values, Cogent said in the report.

The slowdown may also result from LPs having sold what they wanted to from 2004, 2005, 2006, 2007 and 2008 vintages. The supply of more recent vintages may not produce as much volume because overall PE fundraising slowed after the global financial meltdown in 2009 and 2010. This could produce a gap in secondary- market activity, a source in the sector said.

Add to this that banks, which traditionally represented a significant percentage of sellers on the market because of the Dodd-Frank financial-reform rules, are no longer significant sellers, having sold off what they needed to get into compliance, sources said. That’s not to say banks won’t sell any more PE stakes, but they won’t to the levels seen in the past few years.

While sales of traditional LP stakes slow, GP-led transactions like fund restructurings are on the rise and will likely continue to grow in popularity, sources said.

These types of processes can be challenging to complete, however, so even as GP-led deals are increasing, the number of GP-led transactions that have failed has also risen, Cogent said.

Sources say activity will pick up in the second half, as it usually does. We’ll see whether GP-led deals can help drive the market back to its $40-billion-plus volume it’s reached over the past few years.

Action Item: Check out Cogent’s first-half report here: http://www.greenhill.com/content/greenhill-cogent%E2%80%99s-secondary-market-analysis-shows-pricing-remains-steady-despite-slight-dip

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