By Robert McGrath
At Overbay Capital Partners our focus is to mitigate risk and deliver private equity returns for clients. We do this not by buying individual companies but by purchasing mature, diversified portfolios from some leading endowments and pensions.
The portfolios we acquire provide exposure to blue chip private equity funds, and through them, many of the world’s most exciting private companies. And what’s more, we are able to acquire these at a discount, allowing us to generate a substantial return non-correlated with the markets or the performance of the companies we own.
When we meet with family offices, investment advisors and private investors who are considering investing in Overbay, we inevitably get the same question:
"If the assets Overbay is acquiring are so good, why would institutions part with them – and more importantly, why would they do so at a discount?”
There are many reasons why institutions sell, and why they are happy to do so at a discount. Let’s examine three of the most common catalysts in this market that drive Chief Investment Officers (CIOs) or other senior investment professionals to sell portions of their private equity portfolios.
The Overallocation Catalyst
Over the past few years private equity has been a phenomenal performer, far exceeding anyone’s expectations for returns. For instance, PE and VC funds appreciated on average by more than 50% in 2021. Because of this outperformance, by the end of 2021 many institutions were at or above their allocation targets. Then came 2022, during which both bond markets and stock markets dropped in value by significant amounts (15-20%). This has further exacerbated the overallocation issue, and as a result now the majority of institutions are overallocated to private equity.
CIOs continually review their investment weightings against their long-term asset allocation target levels. Institutional investors do not want their programs to be too exposed to any one investment type. Following these last few years, they are finding the time has come to rebalance to bring PE and VC allocations back within the guidelines they set to achieve long-term return targets.
The Illiquidity Catalyst
Another reason institutions reduce exposure to private equity is to be able to fund their obligations. Pensions have to pay pensioners. Endowments often have to pay a large portion of the operating budgets of their universities. Private investments are illiquid, and cash flows they produce are dependent on exits. In 2022 the IPO market has slowed dramatically due to so much economic uncertainty among other factors. M&A activity among private companies has also dropped considerably this year. The impact for CIOs is that anticipated cash distributions from their private investments are not materializing.
Despite the slowdown in exits, institutional investors like pensions and endowments still have to pay pensioners and fund university operations. CIOs may choose to sell some of their private investments to meet these cash flow requirements.
The “Keep Your Seat At The Table” Catalyst
Third and finally, CIOs may need capital to continue investing with the top tier PE and VC firms. Private equity funds from top-tier managers are hard to get into. If you do not consistently invest with those managers in each of their funds, they will not invite you back to their next one.
CIOs must consistently balance annual performance with long-term investing goals. They know that their long-term success in PE and VC depends on continued participation with some of the highest performing – and hence most exclusive – fund managers. These managers value investors that reliably commit to each of their funds so CIOs often make the correct calculation that selling some assets (which have already appreciated and produced good returns) to invest anew is the right move. Any discount on the sold assets can reasonably be expected to be recouped in the outsized performance top tier funds offer.
Summary: Good Reasons To Sell Diamonds
The question we get from investors, “If the assets Overbay is acquiring are so good, why would institutions part with them – and more importantly, why would they do so at a discount?” is an important one.
And while there is no one catalyst to sell, there are many compelling reasons for institutions to not only divest portions of their blue chip PE and VC portfolios – even when it may require a discount to do so.
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