A new mindset is turning decades-old norms into a trillion-dollar global In the private equity industry, fund investors trade their holdings at a record pace like public stocks.
For decades, position swaps in a private equity fund were almost unheard of, as the industry was built on a particular mold of a buy-and-hold model. Investors usually have to keep their money in a fund for at least five years. The fund manager, known as the general partner, is expected to return his or her capital at the seven-year mark as well as any profits.
“In the early 2000s, if you called a general partner and said you wanted to transfer your funds interest, you might be stuck,” said Tom Kerr, global head of US-based Secondary Hamilton Lane said in an interview. Thinking at the time: “You’re gonna be my partner, this isn’t what I signed up for. When I get my next fundraiser, don’t call me.”
That mindset doesn’t fly anymore. “Today, not only is the fund manager ready [a trade],” Mr. Kerr said, “they are embracing it.” According to Hamilton Lane, nearly US$100 billion of global private equity investment is expected to change hands this year, up from US$2 billion annually in the early 2000s. have hope.
The secondary market, as the industry is known, has exploded so rapidly that private equity managers are now raising record amounts of capital for funds whose sole purpose is to buy and sell these private holdings. In February, Hamilton Lane closed its fifth secondary fund and raised US$3.9 billion, the largest amount ever.
Geographically, New York and London are major centers for growing business, but Toronto also has a slew of highly respected players. Brookfield Asset Management recently launched a secondary division. Northleaf Capital Partners, which specializes in mid-market private equity, recently hired the Canada Pension Plan Investment Board’s Head of Private Equity to run its secondary arm. and Whitehorse Liquidity Partners, one of the most well-known names in secondary, was founded by the former head of secondary at CPPIB.
The rapid growth of the secondary market is a reminder of the global rush for alternative investments around 2015. At the time, low-cost exchange-traded funds were taking the shine of mutual funds. In order to generate outsized returns that justified their high fees, institutional money managers began pouring money into non-publicly traded asset classes such as real estate, private loans and infrastructure.
This influx of money also made its way into private equity funds, leading to more sales. Secondary trading started growing After the global financial crisis of 2008-09. According to data from New York investment bank, Jefferies Group LLC, trading volume grew significantly in 2017 and 2018, peaking at US$88-billion in 2019 before the COVID-19 pandemic hit.
Trading has also picked up as private equity norms are changing. The secondary market used to be dominated by institutions such as pension funds and university endowments, which needed to diversify their assets. “If they are overweight in geography, or in a certain area, they can use [secondaries] market to manage your portfolio,” said Michael Flood, head of private equity at Northleaf.
According to Northleaf, this type of activity now accounts for almost half of secondary trading volume. The other half is run by general partners of private equity funds who are “looking to hold their prized assets longer,” Mr. Flood said.
Historically, fund managers had little flexibility. They will use the capital raised by them to invest in the portfolio of private companies. By the seven-year mark, however, they must sell the holdings — often by taking the companies public — to return the capital to fund investors.
But as private markets grow in size, it is possible to hold off private investment for a long time – in fact, some companies may never need to go public. Yet fund investors often want their money back, so the fund manager will help facilitate secondary trades so that the fund remains invested in valuable assets.
The secondary market has also become so sophisticated that there are different types of trading. In addition to buying and selling fund positions outright, some secondary managers offer deferred buys that buy part of the fund’s position, while others sell private preferred shares, a feature of Whitehorse.
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