EUROPE - A worsening of the euro crisis is likely to result in a growing hedge fund secondaries market, according to alternatives secondaries broker Cattegatt.

Lars Lindqvist, founder and chief executive at Cattegatt, said: “If the current euro crisis goes from bad to worse, a new era of crisis will emerge, which will bring major illiquidity and distressed assets.

“Because of this, investors will need to turn to the secondary market to offload their assets, and the secondary hedge fund market will grow, not least in regard to UCITS funds.

“As such a crisis was not anticipated two years ago or three years ago, it is also going to be a test to see how solid these hedge fund structures and strategies actually are.”

But if a meltdown is avoided, Lindqvist questioned whether the secondary hedge fund market in its current form was sustainable in the long run after the sell-off of many illiquid assets in the market.

He said: “The current hedge fund secondaries market is self-liquidating - each time assets are successfully placed and a sale made, a piece of the hedge fund secondaries market disappears.”

As a large portion of sellers has been selling very actively, not least during 2011, supply has been effectively reduced.

“The supply side will be driven by continuous needs to meet capital requirements, as well as internal strategic changes among asset managers,” Lindqvist said.

“On the demand side, you have an increased amount of secondary funds eager to deploy cash, low valuations, which stimulate pricing, unless there is an accelerating meltdown.”

This means that, in general, hedge fund interests on offer within will be smaller in size and consist of the more challenging assets, which the manager has not been able to successfully liquidate, he said.

He pointed to the fact that appetite for such esoteric assets may be of less interest to investors, leading to declining prices.

If meltdown is avoided, Lindqvist expects the hedge fund secondaries market to return to its origins - a secondary market for closed, ongoing funds that trade at a premium or modest discount, similar to the private equity secondary market.

The key issue in the hedge fund secondaries business is the size of the market due to the lack of transparency and how many investors are actually willing to sell their illiquid holdings in the secondary market at a discount, though one could define the market size as any investor who holds an illiquid piece.

Another challenge is pricing, which can be very arbitrary because the assets are opaque, very specialised and can be very complex.

Meanwhile, the outlook for private equity secondaries is more stable, according to Lindqvist, because these are naturally illiquid assets, and, over the years, the secondary market for private equity interests has become almost as mainstream as the primary market itself.

The private equity General Partners, in most cases, produce regular and transparent investor reports, which are used in secondary transactions.
According to Lindqvist, there are significantly fewer buyers of hedge fund secondary interests compared with private equity.

For hedge funds, Cattegatt speaks to around 20 different buyers around the world, while in private equity there is a new call every other day from interested buyers for various kinds of strategies and sizes.

The current hedge fund secondary market has been a result of the crisis in 2007-08 as a need to overcome the mismatch between assets and liabilities, as it serves to help investors who want to sell their illiquid interest in the private over-the-counter market.

Cattegatt has completed deals in more than 100 fund interests ranging in value from just a few hundreds of thousands of dollars to more than $200m (€156m) per transaction.