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

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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

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tag

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nfu

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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

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Perc

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tag

e U

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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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