Buyouts: secondaries school LPs in drawbacks of price opacity

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Secondary private equity deals are becoming a primary concern. Institutions with private capital investments in their portfolios are seeking to trim them. These “limited partners” are using the expanding secondary market to do so, selling stakes in buyout funds or portfolio companies. That should put pressure on private equity’s chunky fees.

Private capital has been feeling strained for a while. Weak markets have made exits harder. The old “two and twenty” formula, which describes annual management and performance fees, rarely applies these days. According to a Financial Times report, private equity fundraisers are offering discounts to entice large investors.

Private equity fundraising is down more than a third through the year to July. Last year, fund management fees, excluding expenses, were just 1.4 per cent says Preqin.

Surging interest rates and last year’s weak public equity market performance have combined to make institutional investors think twice about taking on more private holdings. Betting on the skill of portfolio managers in illiquid markets is no longer a novelty.

Curiously, funds that trade in secondaries are having no trouble raising cash. So far this year, secondaries’ fundraising of nearly $47bn has beaten all of 2022. That made up more than a tenth of all private equity money raised. This year could beat the 2020 secondaries record of $79bn.

That is less odd than it sounds. It reveals that new money has moved into the secondary market looking for bargains just as motivated sellers appear. However, differing expectations make deals hard to close, advisers say.

The opaque nature of private capital might just be to blame for that. “General partners” — buyout executives themselves — have little incentive to mark down prices of portfolio companies to reflect higher risk-free rates of return and lower equity market values. Would-be purchasers of secondaries have every reason to revalue sharply.

This leaves limited partners stuck in the middle, keen to get out but reluctant to stomach heavy discounts.