Investors are selling buyout fund stakes at a record pace

Investors are selling stakes in private equity and venture capital funds at the fastest pace on record this year as the decline in equities spills over to private markets that boomed in the interest rate era down.

Pension funds and sovereign wealth funds were among those that sold $33 billion worth of private equity stakes in the first six months of the year, down from $19 billion in the same period of 2021, according to Jefferies, usually selling them below face value.

The sale follows a decade of increased allocations to private markets, which have grown in influence since the financial crisis and cover everything from buyout companies to venture capital and real estate funds.

This casts doubt on the ability of these groups to sustain the fundraising that has turned them into a major force in global bargaining.

Pension funds say the decision to ditch equity stakes was partly triggered by the sharp decline in stock markets, leaving their overall portfolios too exposed to buyout funds and other private investments whose value has not been reduced by the same way.

“We’ve never had to do this before, and we hoped we never would have to,” said the head of private equity at a pension fund that sold some of its fund stakes. redemption at a reduced price. “We will also be reducing the amounts we commit to new private equity funds this year and next.”

At the same time, pension funds that had committed money to buyout companies have actually had to rack up money much faster than expected over the past two years due to the trading frenzy.

That has raised fears of a funding crunch, according to a senior executive at a foundation that invests in private equity, as some pension funds fear they won’t have enough cash to meet future capital calls from buyout funds. to which they are committed.

Investors are “desperate to get into a full cash crunch and have to start selling things, so they’re trying to get the upper hand” by selling stakes now, he said.

” Division [money handed back to investors from successful deals] were at an incredible rate over the past five years” and investors assumed that would continue, allowing them to meet new calls on their funds, he said. “Instead, they almost completely died out.”

Unlike publicly traded securities which can be easily bought and sold, investments in private funds are typically locked in for around a decade and their value is determined using a sophisticated guesswork process.

However, holders of these illiquid stakes can safely sell them on a secondary market, either to other pension funds and sovereign wealth funds, or to specialized groups called “secondary” companies. These niche investment groups have about $227 billion, raised in part for such deals, according to Jefferies.

While some investors routinely sell their former private fund holdings, nearly half of this year’s deals were with a first seller, Jefferies estimates. The volume of these sales is always higher in the second half of the year, putting this year on track for a record if the pattern repeats itself.

On average, stakes in buyouts, venture capital funds and real estate funds were sold for only 86% of their nominal value in the first half of the year, the largest discount since the period of market turbulence at the start of the coronavirus pandemic, according to Jefferies.

Venture capital fund holdings have been sold at 71% of their most recent valuation, underscoring how rising interest rates and fears of a recession have dampened investors’ willingness to back start-ups -up often unprofitable.

Private equity groups generally believe that an investor makes more money if they hold the stake until the end of a fund’s life. But the seller doesn’t necessarily lose money overall, because the fund may already have repaid enough successful trades to earn a positive return.

Sale of private equity: how it works

A trader looking at a monitor

© Reuters

Assignment rules

Many pension funds and other investors have rules on how much of their total assets can be allocated to private markets

exceeding the limits

Some have exceeded this limit for two reasons. Buyout companies have been calling pension fund commitments faster than expected over the past two years due to their flurry of deals. At the same time, falling stock markets left funds with excessive weighting in private markets

reduce exposure

They must therefore reduce their exposure to private funds to return to their target

facing a crisis

Sometimes the need is even more acute because the pension fund or other investor may run out of cash. During the typical 10-year lifespan of a buyout fund, its managers ask pension funds for money when they buy portfolio companies and give them money when they sell them back – referred to as “capital calls” and “distributions” respectively.

cash recycling

Some investors planned to use the money from the new distributions to fund new capital calls. But as trading ceased this year, distributions dried up. Capital calls could also fall as buyout groups strike fewer deals, but some investors still need to free up cash by selling stakes in older funds

output

But they committed to the private fund for a decade, an illiquid investment. The only way out is to arrange privately to sell your stake in the fund to another investor – either a pension fund and a sovereign wealth fund, or a second-hand specialist buyer.

a deal is done

If agreed, the buyer takes over the seller’s interest in the private fund. It is at the mercy of future capital calls and entitled to future distributions

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