As the amount of money committed to private equity funds has grown, the secondary market for selling fund interests has similarly expanded. Moreover, recent events in global financial markets are likely to increase further the volume of secondary transactions.

Until recently, the most common reason for an investor seeking to sell a fund interest was simply a change of investment strategy. This may well have been a desire to focus on a specific area (for example, buyout funds or emerging markets). Today, however, the falls in value of many asset classes are causing a wider range of investors to carry out fundamental reviews of their asset allocation strategies. This may result in a decision to alter exposure to private equity which can give rise to a sale of existing commitments.

Long term investors in private equity may use the current downturn as an opportunity to re-evaluate their exposure to specific fund managers (general partners), as they look to focus on those managers who they believe will out-perform over the next market cycle.

Until recently distributions (realisations) from private equity funds were at record levels, resulting in investors having difficulty in achieving their target exposure to the asset class. A common strategy to address this issue was to implement an 'over allocation' policy. The objective was to achieve the desired asset exposure by over-committing to new funds in the expectation that, net of subsequent distributions, the desired allocation to the asset class could be achieved. The sharp decline in realisations by private equity funds and consequent lack of distributions has left many investors over-committed. This imbalance is exaggerated by the 'denominator effect'; falls in values of other asset classes in investors' portfolios have further increased their relative exposure to private equity.

Many investors in private equity have found themselves short of liquidity for reasons unconnected with their private equity investments. As and when private equity managers resume investment activity and make calls on outstanding capital commitments, some investors may have difficulty meeting their commitments. The expectation of this is encouraging some investors to sell assets early to avoid the risk of being in default of a future capital call. Being in default can give rise to serious adverse commercial and legal consequences for an investor.

An anticipated increasing in the regulation of private equity may cause investors to want to sell existing investments. While the impact on private equity funds and their managers will vary depending on jurisdiction, some investors may be forced to sell because their private equity portfolios are re-designated as non-qualifying assets or require an increased regulatory capital allocation.

In summary, we believe the secondary market for private equity fund interests is set to grow, and funds raised by larger conventional secondary firms are anticipated to increase in size as the market for fund-raising improves. Hollyport Capital specialises in smaller and often more complex transactions, typically under $20m, which are of less interest to large secondary investors seeking to deploy substantially larger funds.