Largely forgotten in the conversation about new developments in illiquid alternative asset investing is the growing amount of aging assets across various strategies.
In 2017, amidst the deluge of articles and anecdotes supporting passive index-focused investing, illiquid alternative asset strategies continued to experience fundraising success, with private equity leading the way. Private equity strategies raised more capital in 2017 than in 2016, and the average fundraise surpassed the previous peak for average fundraising reached in 2007.1 The alternative assets conversation in 2017 was all about new and next, whether it was Softbank’s Vision Fund, Apollo’s largest-ever private equity buyout fund or renewed interest in infrastructure strategies.
Largely forgotten in the conversation about new developments in illiquid alternative asset investing is the growing amount of aging assets across various strategies. Globally, there are approximately 3,000 alternative asset funds greater than 10 years old, representing an estimated $450 billion of net asset value.2 Alternative asset fundraising success contributes to this backlog of aging assets, which has more than quadrupled in size since 2012.2 Investors are attracted to alternatives by the returns, but they are often trapped in aging alternative assets due to the challenges posed by fully realizing a portfolio of aging assets.
Investment holding periods have been rising steadily for the last decade, and managers continue to oversee funds that are well past their operational terms. In many cases, managers of these vehicles discontinued collection of management fees long ago, and investors would like to divest their interests in the funds for managerial and strategic reasons.
As the amount of aging illiquid alternative assets has grown, interest in the secondary market for these assets has increased commensurately. The secondary market for alternative assets has established itself as a useful portfolio management tool, expanding beyond its historical role as a last resort for distressed sellers. Investors have expressed their support for the strategy, driving secondary fundraising to record levels in 2017. As a result, secondary investors possess a record amount of dry powder that is ready to be deployed.
The confluence of record amounts of aging illiquid alternative assets and secondary dry powder presents a significant market opportunity for both buyers and sellers of these assets. And yet, despite the secondary market’s growth in terms of size and sophistication, alternative asset managers and investors rarely view secondary market activity as strategic. Financial markets are inherently forward-looking, and older assets often receive minimal attention.
While secondary market activity may not be a top priority for alternative asset managers and investors, there are material benefits to be gained from addressing the growing backlog of aging alternative assets. Managers of aging funds can (i) create liquidity for their investors through individual asset or portfolio sales, (ii) wind-down legacy funds and (iii) restructure funds to bring in new capital and better support portfolio companies. Investors can divest aging assets to (i) meet investment allocations, (ii) reduce portfolio monitoring burden, (iii) generate needed liquidity and (iv) comply with regulatory requirements. And from initial planning through closing, specialized secondary market advisers stand ready to help sellers navigate transactional, regulatory and other secondary market considerations.
After raising a record amount of capital in 2017, it is anticipated that 2018 will be another strong year for capital deployment by secondary investors. Secondary market pricing, which has been rising steadily over the last few years, will likely continue to improve. In such an environment, managers of and investors in aging assets should consider strategic participation in the secondary market.
1 Preqin Private Equity & Venture Capital Spotlight–December 2017