As the number of publicly traded companies is shrinking, the appeal of private equity is growing. At the end of 2016, private equity funds held a record high $2.49 trillion assets under management, including $820 million in “dry powder,” or money available for new opportunities, according to Preqin, the London-based research firm.
Despite its growing appeal, private equity has always been limited by illiquidity. Memories are still fresh of 2008, when major university endowments and other institutional investors offered billions of dollars in private equity holdings for sale at big discounts in the secondary markets. The fear of fire sales lingers.
Those worries could ease if a new secondary market auction platform by Nasdaq Private Market (with regulatory relief granted by an SEC order) succeeds in what the exchange describes as an effort to streamline “the administrative burden of providing shareholder liquidity through an end-to-end technology solution.”
Here’s why I think the illiquidity issue is getting traction and why Nasdaq’s move is well-timed. More retail investors are gaining access to private equity and other illiquid assets through select ’40 Act funds, sometimes referred to as “interval funds.” You could call this Phase I of mainstreaming private equity. These funds are closed-end SEC-registered investment funds but are not listed on any exchange. Thus, they can be offered to a wider audience (of suitable and qualified investors) than traditional private equity funds, and often at much lower minimums.
But there is a wrinkle to interval funds, which both helps and hurts investors. Unlike regular or even “liquid alts” mutual funds, which offer daily redemptions at net asset value, investors in interval funds can only redeem shares at set times and in limited amounts. That may alleviate the danger of a stampede of investors in the midst of a downturn, but still leaves the liquidity issue. Investors could turn to the one of some 485 secondary marketers, as happened in 2016 when volume in the private equity secondary market reached its near record peak, but it can be a time-consuming process, and the discounts can be big.
Alts Go Mainstream
The new platform, NPM Alternatives, is taking a different approach. Instead of a one-off sale, NPM Alternatives will aggregate buyers and sellers to create a more open and informed market. Whether it’s an individual who wants to sell a $150,000 commitment or an institutional investor looking to buy a $10 million position, they can all meet in the same place to participate in an auction.
If it succeeds, I believe NPM Alternatives could be Phase II of private equity mainstreaming. The mechanism may further help alleviate a cascade of redemptions, since the transactions are in the secondary market and don’t drain capital from a fund.