Private-equity has been an incredibly popular investment tool for institutional investors around the world, and in 2012 the industry surpassed $3 trillion of assets under management. The popularity of this form of investing is generated from the enormous success that Private Equity has attained with many funds regularly providing a return on investment above 20%. This rate of return does not come without issues, though.
The most salient of which is the illiquidity of the investment. Limited partners of the fund commit their money for about a decade before receiving the returns during the winding down of the fund. Furthermore, in the past investors in the secondary market for these securities would only invest at a steep discount. Yet, due to the rising stock market, among other reasons, the secondhand trading in private-equity limited partnership assets has increased dramatically.
Some of the previous investor hesitation could be the serious considerations that arise when investing in these secondary markets. For example, these investors are responsible for any cash commitments that the previous investors made to the funds that have not yet been spent. In addition, it is difficult or nearly impossible to purchase partnership units in the highest performing funds, and moreover, the chance of hitting an investing homerun decreases when investing in the later stages of a fund.
These potential concerns come with potential upsides as well, however. While the investors may not see outsized returns, they are able to reduce the risk inherent with investing cash in a blind pool. Generally, the investors can see which assets the fund has invested in and make a better analysis of the risks associated with the investment. Additionally, if they invest late enough, they are able to skip the fees that are paid to fund managers during the investing stage.
Whatever the reason, it is clear that investors have been participating in the secondary market for these securities. While not consistent across data providers, as some of these transactions go undisclosed, Cogent Partners, an investment bank that specializes in the alternative asset aftermarket, claims that $27.5 billion were traded last year alone. The demand for secondary trading of private-equity limited partnership units is on the rise, and investors should be on the lookout.