Liquidity in the Secondaries Private Equity Market
Anya Kleymenova
Eli Talmor Florin P. Vasvari
Coller Institute of Private Equity October 2012
Page 2
Main Objectives
1. Investigate determinants of the liquidity of private equity fund interests
2. Assess the impact of liquidity on the pricing of private equity fund interests (also a validity test for our liquidity measures)
3. Introduce institutional aspects of the secondary PE market
Sales of Fund Interests
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New Investor
Fund
Investor 2
Company 2 Company 1
GP
$
Secondary Buyer Replaces Investor 2
Investor 2 achieves cash exit
Investor 1
Secondary transactions by year
Page 4
Source: Coller Capital, 2012
Main Reasons for Selling a Private Equity Interest
Page 5
Source: Coller Capital, 2010
Buyers of Private Equity Interests
Page 6
Source: Cogent Partners 2009
Average Pricing of Fund Interests
Page 7
Source: Cogent Partners, 2012
Different Sales Processes
LPs can arrange a sale through the GP
LPs can decide to negotiate directly and exclusively with a single dedicated secondary buyer
LP can sell via an auction (open or managed by an advisor) – Cogent Partners is one of these advisors/intermediaries
Page 8
Page 9
Motivation
Due to the recent financial crisis and regulation LPs requests to sell the private equity funds interests they own have increased
Banks and other financial institutions are selling more of their PE fund interests to comply with the recently approved Volcker rule and in anticipation of Basel III / Solvency II
Buyers are increasingly attracted to this asset class due to its growth and opportunities
However, very little is known about the liquidity of the secondaries market
Confusion between Liquidity and NAV discount
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Academic Motivation
Sources of illiquidity in equity and bond markets (e.g., Amihud and Mendelson, 1986; Amihud 2002 and Chen, Lesmond and Wei, 2007) – Transaction costs – Lack of demand – Search costs – Information asymmetry
Systemic liquidity risk – Role of co-movement of an asset with the overall market – E.g., Pastor and Stambaugh (2003), Acharya and
Pedersen (2005) and Bushman, Li and Vasvari (2010)
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Measures of Liquidity in the Literature
A number of measures have been proposed:
Direct measures
bid-ask spreads, trade size and volume, bid dispersion and return per volume of trade
Indirect measures
characteristics of the security
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Data
Anonymised data on auction bids provided by Cogent Partners
Bidders submit both portfolio and spot bids – we focus mainly on spot bids
Sample period 2003-2010, 75% of funds raised during 1999-2009
Full sample of 28,811 portfolio and spot bids in the first round (554 unique bidder-year observations)
Recently replicated analysis using an updated sample until Dec 2011
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Sample Composition – Distribution by Year
YearNumber of
Bidders
Number of
Bids
Average
Bid
Number of
Spot Bids
Average
Spot Bid
2003 39 607 0.6253 201 0.5784
2004 38 1,110 0.7088 1,068 0.7009
2005 57 6,417 0.8341 6,062 0.8313
2006 60 7,778 0.9128 7,479 0.9099
2007 90 4,427 0.8831 3,583 0.8765
2008 76 4,594 0.7063 4,242 0.7247
2009 108 2,034 0.4329 1,883 0.4129
2010 86 2,451 0.7581 2,215 0.7581
Total 554 28,811 0.7480 26,532 0.7449
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Liquidity Proxies and Auction Data
Use data collected during the first round of bidding – Second round bids are likely to be less informative about
liquidity due to the structure of the auction
Estimate three measures of liquidity: 1. Number of bids received for a fund interest 2. Excess demand (total value of bids received minus the
maximum bid / fund size) 3. Negative of standard deviation of bids
Results are robust also to other measures (bid range, days on market)
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Main Drivers of Liquidity i) Fund characteristics
Type, geographical focus, size, level of funding and distributions
(ii) Extent of information asymmetry between counterparties
Seller type, bidder type and market participation and GP’s restrictiveness
(iii) Overall market conditions
Equity market volatility and average secondary market pricing
Liquidity and Level of Funding
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0
2
4
6
8
10
12
14
pre-
2005
2005
H1
2005
H2
2006
H1
2006
H2
2007
H1
2007
H2
2008
H1
2008
H2
2009
H1
2009
H2
2010
H1
2010
H2
Nu
mb
er
of
Bid
s
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
Perc
en
tag
e U
nfu
nd
ed
Number of Bids Percentage Unfunded
0
2
4
6
8
10
12
14
16
18
20
pre-
2005
2005
H1
2005
H2
2006
H1
2006
H2
2007
H1
2007
H2
2008
H1
2008
H2
2009
H1
2009
H2
2010
H1
2010
H2
Excess D
em
an
d
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
Perc
en
tag
e U
nfu
nd
ed
Excess Demand Percentage Unfunded
0
0.02
0.04
0.06
0.08
0.1
0.12
0.14
0.16
0.18
0.2
pre-
2005
2005
H1
2005
H2
2006
H1
2006
H2
2007
H1
2007
H2
2008
H1
2008
H2
2009
H1
2009
H2
2010
H1
2010
H2
Vari
ati
on
in
Bid
s
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
Perc
en
tag
e U
nfu
nd
ed
Variation in Bids Percentage Unfunded
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Drivers of Liquidity (1) (2) (3) (4) (5) (6) (7) (8) (9)
Number of
Bids
Number of
Bids
Number of
Bids
Excess
Demand
Excess
Demand
Excess
Demand
Variation
in Bids
Variation
in Bids
Variation
in Bids
Buyout 0.1007*** 0.1055*** 0.1257*** 0.1202*** 0.1250*** 0.1448*** 0.0082** 0.0084** 0.0033
(4.794) (5.023) (6.374) (4.938) (5.138) (6.491) (2.255) (2.312) (0.901)
North American fund -0.0533** -0.0572** -0.0617*** 0.0078 0.0038 -0.0023 -0.0050 -0.0060 -0.0088**
(-2.217) (-2.380) (-2.578) (0.260) (0.127) (-0.079) (-1.214) (-1.452) (-2.009)
Fund size 0.1061*** 0.1009*** 0.1031*** 0.1396*** 0.1348*** 0.1387*** 0.0122*** 0.0110*** 0.0096***
(13.293) (11.801) (12.538) (14.094) (12.941) (14.225) (8.622) (6.756) (5.798)
Percentage distributed -0.0935*** -0.0926*** -0.0876*** -0.0860*** -0.0848*** -0.0846*** -0.0000 -0.0005 -0.0005
(-7.570) (-7.391) (-7.301) (-5.900) (-5.756) (-6.281) (-0.013) (-0.196) (-0.195)
Percentage unfunded -0.1279** -0.1005* -0.2942*** 0.0661 0.0938 -0.1555** -0.0926*** -0.0932*** -0.0877***
(-2.233) (-1.752) (-5.250) (0.996) (1.407) (-2.453) (-3.923) (-4.044) (-3.849)
Sophisticated seller 0.5898*** 0.5767*** 0.1511*** 0.6050*** 0.5914*** 0.0579 -0.0405*** -0.0380*** -0.0078
(11.768) (11.458) (3.108) (6.907) (6.695) (0.739) (-4.260) (-4.016) (-0.764)
GP with funds for sale during prev.
year
0.0811*** 0.1157*** 0.0802*** 0.1227*** 0.0053 0.0041
(3.691) (5.473) (3.207) (5.257) (1.395) (1.103)
Restrictive GP -0.3053*** -0.3023*** -0.3221*** -0.2790*** 0.0520*** 0.0488***
(-7.355) (-6.976) (-5.700) (-5.001) (3.897) (3.199)
Volatility (Round 1 date) -1.0510*** -2.3734*** 0.1434***
(-6.207) (-12.510) (6.750)
Average market bid (LPE) 0.1007 0.3610** 0.0029
(0.770) (2.265) (0.097)
Percentage of sophisticated buyers -0.9848*** -1.1823*** 0.0273*
(-16.361) (-17.197) (1.945)
Percentage of bidders with other bids -0.0842* -0.1503*** 0.0509***
(-1.753) (-2.850) (5.070)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
Observations 4,108 4,108 4,108 4,108 4,108 4,108 2,302 2,302 2,302
Adjusted R-squared 0.30 0.31 0.40 0.40 0.40 0.50 0.12 0.12 0.15
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Sensitivity Tests
Results are similar when we use alternative measures for liquidity
Results are similar when we include portfolio bids in the sample.
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Effect of Liquidity on Pricing Panel B (1) (2) (3) (4) (5) (6)
Final Bid / LPE
Index Bid
Final Bid / LPE
Index Bid
Final Bid / LPE
Index Bid
Final Bid / Avg
Mkt Bid
Final Bid / Avg
Mkt Bid
Final Bid / Avg
Mkt Bid
Number of Bids 0.0249*** 0.0482***
(3.886) (4.166)
Excess Demand 0.0441*** 0.0882***
(7.950) (8.924)
Variation in Bids 0.0965*** 0.1735***
(3.890) (3.424)
Buyout 0.0303*** 0.0262*** 0.0333*** 0.0555*** 0.0471*** 0.0576***
(6.246) (5.466) (7.259) (5.755) (4.954) (6.297)
North American fund 0.0399*** 0.0384*** 0.0313*** 0.0472*** 0.0442*** 0.0373***
(5.877) (5.708) (5.332) (3.741) (3.600) (3.397)
Fund size 0.0031 0.0006 0.0110*** 0.0122*** 0.0071 0.0207***
(1.301) (0.250) (4.972) (2.642) (1.494) (4.774)
Percentage distributed -0.0113*** -0.0097*** -0.0041 -0.0240*** -0.0206*** -0.0076
(-4.680) (-4.151) (-1.410) (-4.446) (-3.955) (-1.556)
Percentage unfunded 0.0329** 0.0316** 0.0534*** 0.0372 0.0347 0.0882***
(2.232) (2.149) (3.969) (1.381) (1.303) (3.205)
Sophisticated seller 0.0402 0.0330 0.2317*** 0.0251 0.0085 0.2547***
(1.014) (0.886) (6.855) (0.426) (0.155) (4.974)
GP with funds for sale during previous year -0.0010 -0.0054 0.0057 -0.0143 -0.0232** -0.0007
(-0.199) (-1.059) (1.243) (-1.360) (-2.208) (-0.076)
Restrictive GP 0.0093 0.0168 -0.0874** -0.0075 0.0083 -0.1826*
(0.413) (0.773) (-2.108) (-0.146) (0.168) (-1.669)
Volatility (Round 1 date) 0.3861** 0.3830** 1.3337*** 1.5251*** 1.5160*** 2.5111***
(2.397) (2.334) (14.514) (6.091) (6.297) (12.995)
Percentage of sophisticated buyers -0.0561*** -0.0322* -0.1185*** -0.0528 -0.0032 -0.1708***
(-3.090) (-1.793) (-5.768) (-1.434) (-0.090) (-3.640)
Percentage of bidders with other bids -0.1357*** -0.1089*** -0.1742*** -0.1274*** -0.0719** -0.1621***
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Conclusions
A PE fund interest is more liquid if the fund: – Is larger; – Focuses on buyouts; – Has less undrawn capital and fewer distributions; – Has a GP with funds previously traded on the secondaries
market; – Has a dedicated secondary fund as a seller; and – Has non-traditional buyers placing bids
Liquidity is also higher in less volatile economic conditions
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Conclusions
Validation test: All three liquidity proxies are significantly and positively associated with the pricing
– more liquid funds are sold at higher prices
Variables associated with the fund interests’ marketability can be used to infer a “liquidity score”
– Can help adjust the expectations of bidders and sellers
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