Family Offices Stand to Benefit from Dwindling Private Market Liquidity
The rapid shift from bull to bear market, rising inflation and impending recession offers a unique set of challenges and opportunities for investors.
We’re already seeing that the current environment is forcing institutional investors to drastically reduce allocations to private assets, creating an expanding liquidity gap that will be filled, at least in part, by more nimble, opportunistic investors.
Well-managed family offices stand to be among the beneficiaries of dwindling private market liquidity, particularly considering their growing appetite for private equity and direct investments. According to a recent report published by Dentons, 63% of family offices participate in direct investments and an additional 22% are interested in doing so. The law firm surveyed 188 family office respondents from 32 countries.
And given that family offices enjoy greater flexibility in managing allocations among private and public asset classes we should expect this investor category to grow beyond their current 12% share of private asset allocations.
Chief Investment Officers (CIO’s) in family offices are getting clipped by a denominator effect right now due to private valuations not moving too much. That is likely to change as valuation marks get updated. It could lead to family offices over-allocating to private markets as it will make them “look good” when these assets don’t move as much as in down markets, i.e., a CIO looks smart to the head of the family but putting more eggs into a private basket that doesn’t move. This pricing lag can have the benefit of enabling more time for asset price recovery.
-Jamie Wildman, Partner, Merchant Banking, William Blair (Dentons)
Presently, within the institutional investor world, this so-called denominator effect is curiously leading to the opposite outcome, specifically, as public market valuations drop, institutions are forced to rebalance their portfolios by cutting private asset exposure. As a result, there were fewer funds raised during the first half of 2022 than any other six-month period since 2013.
Institutional investor efforts to further reduce private market exposure is reflected in private equity secondary activity, which reached a record $54bn in volume during the first half of 2022. And within the private equity secondary market, direct investing GP’s (i.e., not fund of funds or secondary funds) accounted for 33% of all sellers, as they looked to tap the secondary market to create liquidity for their LP’s, according to Setter Capital.
Among emerging private asset opportunities, the private equity secondary market offers various options through which family offices can capitalize on current market dislocations. According to a recent Unigestion report, secondary market trades reflect a decline of 35–45% for Venture and Growth Funds and a 10–25% drop for Buyout Funds. Private market valuations for venture capital, growth capital, large buyouts and more cyclical sectors likely have more downside given the lag between public and private valuations.
However, at Emerge9 we’re seeing a mix of single and multi-asset GP-led secondary mid-market deals within non-cyclical sectors, most notably healthcare and business services. Our focus has been on businesses with leading market positions, rollup strategies to take advantage of buying opportunities, and strong business fundamentals, including high free cash flow conversion rates. Depending on the speed at which we see some convergence between public and private valuations, we could see an upsurge in secondary deals across a broader set of deal types (i.e., mega buyouts and growth).
