What SVB's collapse means for secondary investments

Investors seeking exposure to the private markets can find opportunities – as long as they're patient

What SVB's collapse means for secondary investments

While the collapse of Silicon Valley Bank was a shock to many investors, one top investment advisor says it’s only added to the appeal of a lucrative and growing corner of the alternative investment world.

“There's a lot of opportunities on the secondary market, especially with SVB,” says Francis Sabourin, portfolio manager and investment advisor at Richardson Wealth. “They own a lot of stakes or investments in private equities, which they will need to sell on the market at deep discounts. For those buyers on the secondary markets, maybe SVB would be an opportunity to buy pieces of great portfolios.”

Though it’s been the focus of media attention of late, SVB doesn’t have a monopoly on liquidity challenges by any stretch of the imagination.

The drastic increase in interest rates of 2022 put pressure on many balance sheets across the investment universe. Against that backdrop, many institutional investors and pension funds elected to sell their stakes, unleashing a torrent of secondary shares. With rates remaining high and uncertainty still rampant, Sabourin expects that dynamic to reverberate well into 2023.

To unload their shares and get cash quickly, he explains, sellers like SVB will have to offer fire-sale prices. And since it’s not the fund itself that’s distressed, but the unitholder, the shares would still be attractively priced relative to what’s being offered on the market.

“Even when things are going well, there’s always someone somewhere who needs to sell for any given reason – a new mandate, or a liquidation,” he says. “These days, it’s been about adjusting asset allocations within the portfolio because equities tanked and private equity expanded. Some allocators may also want to sell their existing PE fund shares to buy shares of a new fund.”

For those looking to snap up secondaries, Sabourin says, due diligence is key. Having a process in place and being knowledgeable about the sector in question is crucial, as well as doing your homework on sellers to make sure deals don’t fall through. Because the private-markets space can be treacherous for the uninitiated, he says it’s important to partner up with an experienced person, team, or firm who knows what questions to ask.

The lifespan of a private equity fund tends to be in the neighbourhood of 10 to 12 years, Sabourin says, with a performance profile that follows a J-curve: an initial period of negative returns followed by the potential for a sharp takeoff later on. Those looking to avoid the initial negative-return phase of a private equity fund, therefore, will want to buy secondary shares of funds in their seventh year.

“I’ve looked at many, many portfolio managers that specialize in secondaries,” he says. “Most of the time, it’s the best-performing asset class within the private equity category.”

And while everyone likes a good discount relative to market, he says investors and investment professionals should weigh other factors when hunting for bargains. Will exposure to the fund diversify the portfolio better? Who are the managers? What are the costs involved?

Based on statistics from Greenhill, secondary deals executed globally totalled US$11 billion in 2009; by 2021, that market exploded to US$130 billion. Whereas equity markets are susceptible to rollercoaster ups and downs, patient investors who keep their ears to the ground can always find good opportunities in the secondary market.

Blackstone’s recent US$25-billion close of a secondary fund – an unprecedented amount for the category, Sabourin says – speaks to the appetite for this type of alternative exposure. And while some secondary shares that target particular sectors may prove more appealing than others, he believes diversified exposure is the way to go.

“You could focus on the tech sector and get exposure to private companies that will go public in a couple of years. Some investors are selling their shares of those types of funds for a 30% to 40% discount,” Sabourin says. “But you may be better off buying secondary funds-of-funds than going for one particular sector, because you already expect a discount and good performance from the asset class. Why take that extra concentration risk?”