(SINGAPORE) Distressed selling may be a thing of the past, but prospects in the secondary private equity (PE) market are definitely looking up, says Paul Capital, a global alternative investment manager with US$6.6 billion in assets under management.

 

'Whether it is fundraising activity, investor interests or exits, we see encouraging signs on all three fronts,' the company's regional head, Lucien Wu, told BT in a recent interview.

 

A niche sub-market of the PE space, the secondary market is commonly used to trade second-hand PE assets by investors hoping to rebalance their portfolios or realise liquidity.

 

Even then, the segment had endured a slow 2008 and parts of 2009, despite expectations that the financial crisis could trigger a spike in secondary trades among investors seeking to cut their losses.

 

Large secondary fund, Lexington Partners, had earlier estimated that as much as US$52 billion in primary fund commitments and US$1 billion of portfolios of companies held in a fund - called secondaries direct - could have been up for sale in 2008, as investors sought to conserve cash or increase their liquidity as public markets collapsed in value after Lehman's demise.

 

However, the market saw only about US$20 billion of transactions go through in that period, as sellers were not willing to accept discounted offers despite the sharp writedowns of up to 30 per cent in the closing months of 2008.

 

'The sellers had continued to benchmark the asset values to the transacted prices seen in the last bull run,' said Mr Wu.

 

As a result, the strong buyer interest did not ultimately translate into higher transaction volumes.

The good news, however, is that as capital market conditions improve, the bid-ask spreads should narrow and trigger a pick-up in deal flow.

 

The signs of the pick-up in activity are already evident from Harbourvest's set-up of a new clean-technology fund of funds and the purchase by Kohlberg Kravis & Roberts, a big primary fund, of Oriental Brewery, South Korea's largest brewery, for US$1.8 billion.

 

In terms of exits, Paul Capital also sees more initial public offerings (IPOs) coming out of China, pointing to the IPO of Carlyle-invested China Pacific Insurance Group in Hong Kong, which raised US$3 billion. Also, panic selling in other markets appears to have eased.

 

'The improved conditions in the capital market are good for us, since there is now more visibility on asset values and required returns,' Mr Wu said.

 

He is not concerned that the buoyant market conditions could imply less distressed assets sold in the secondary market, since there are other factors that drive investors to realise liquidity through secondary trades.

 

First, there is still a large gap between potential capital calls and potential distributions.

 

'Investors often use distributions to fund future capital calls. We are going into an environment with more capital calls and perhaps less distributions,' Mr Wu said.

 

This will presumably exert more pressure on investors to find liquidity, especially in the case where a portfolio is underfunded - a boon for the secondary market.

 

The niche market is also helped by non-cyclical factors such as changes in government regulations, which makes it relatively more immune to conditions in the capital markets.

 

One example is the regulatory pressure on banks and insurance companies to hive off their non-core assets, which drives some of these financial institutions to offload their stakes in the secondary market.

 

Also, the secondary market serves as an avenue for corporate spin-offs, which is typically less correlated to prevailing market conditions.

 

'Plus, investors such as endowment and pension fund managers still see sales in the secondary market as a means of rebalancing their portfolios, and that is not likely to change any time soon,' Mr Wu said.