Hedge and private equity secondaries market fortunes set to diverge in 2012, broker predicts

Secondary trading markets for hedge and private equity funds will be transformed in the first half of next year – but in very different ways to one another, say brokers Cattegatt Capital.

For hedge funds, Cattegatt estimates about $200m of stakes will enter markets by June, but the market overall will continue to shrink. Volume already declined about XX since XXXX, to $20bn.

Lars Lindqvist (pictured), founder and CEO of Cattegatt, says: “Liquidation of hedge funds have been active in 2010- 2011, so the volume has shrunk, and will continue to shrink.

“I doubt the hedge fund secondary market will be sustainable in its current form because it is self-liquidating – each time assets are successfully placed and a sale made, a piece of the hedge fund secondaries market disappears. As a large portion of sellers have been selling very actively, not least during 2011, supply has been effectively reduced.”

For private equity, by contrast, Cattegatt estimates European banks will have to offload $2.5trn of ‘non-core’ assets by June to meet regulatory requirements.

German and UK banks will need to divest $500bn – all fuelling the private equity secondary markets significantly, according to Lindquist.

He says in the first half of 2012 Cattegatt has about $100m of firm, exclusive private equity deal flow to place, “but we expect significant volume to crystallise”.

In the short-term hedge fund secondaries volume will also grow, and Cattegatt has $XXm confirmed deal flow including three hedge portfolios private banks have asked it to place during next quarter.

Cattegatt already saw tender offers for special credits, PE-type holdings in agriculture and shipping funds, and tender offers for full loan portfolios. “Such tender offers may be attractive solutions for many hedge fund managers, since it offers a full liquidation to one single counterparty, rather than sell-off over a longer time”.

Lindquist says inflow over the coming six months will include about $7bn in event-driven fund stakes, $3bn in asset-backed lending and private investment in public equities (Pipe) strategies and $10bn in assorted other strategies.

Cattegatt focuses on interests in illiquid assets in private equity, hedge funds, and other assets including collateralised loan and debt obligations.

Lindquist notes his firm brokered about $30m in ABL funds this quarter, “unseen in the first quarter, because investors are looking at more esoteric funds where prices still are low.” Cattegatt also helped transact African mining interests, and life settlements.

But such scales will occur against a backdrop of dramatic slowing of deal flow, and continued shrinking of the market overall.

“In general, hedge fund interests on offer within secondaries markets will be smaller in size and will consist of the more challenging assets, which the manager has not been able to successfully liquidate. This points to the fact that appetite for such esoteric assets may be of less interest to investors which will lead to declining prices.”

Lindqvist said: “Another factor that points to a reduced market size is the trend to make tender offers. As fund managers liquidate assets and funds become smaller, this in turn makes them interesting for investors to make full tender offers to purchase the remaining balance.”

If there is “renewed meltdown” on markets and among funds, the trend of market contraction could all change, and Lindquist hints somewhat contentiously the secondaries market could change once more.

The minimum fortnightly liquidity of Ucits alternative funds means they have not appeared on secondary markets, as investors need not wait long to exit, so need not use secondary markets.

Lindquist says: “If the euro collapses you will have a domino effect throughout the financial system and this will result in major illiquidity. As a result, the hedge fund secondary market would accelerate, not least in regard to Ucits funds which, if worse comes to worse, may prove not to be so liquid as many may think – but this is what we don’t know.”

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