Staying on track. Gravity railroads, where gravity alone is used to move minerals or passengers downhill were popular in the nineteenth century. The first, the Ffestiniog Railway was in a state quarry in Wales, but eventually they became common in Eastern U.S. coal fields. Steam engines or horses were used to power empty cars back up the slopes. A 47 mile route from Pittston, PA to Paupack Eddy, PA was one of the longest. Today this reliance on the gravity railroad technology is largely used on the downslope of amusement park roller coasters. Reliance on gravity (or anti-gravity) has crept into asset allocation models. The anti- gravity effect is an underlying assumption where fiduciaries reallocate capital away from private equity funds by selling fund interests via the secondary market. Anti-gravity is needed to make the sellers’ math work.
If a secondary sale is being planned due to a reallocation decision, some basic analysis is required. If one is selling because of a distrust of NAV marks, financial need or for other external reasons, the analysis is different. If an investor sells $1000 of NAV @ 85 or $850, the following math results:
- We assume that no tax is due on the sale if the $850 exceeds tax basis, which would widen the gap herein.
- If the re-invested $850 compounds at 8%, above today’s actuarial rates, in four years it would be worth $1081.
- If the original $1000 had grown at 8%, it would be worth $1364, or if grown only at 5%, it would be worth $1214.
- In either case, the divested secondary valuation would not reach break even after a four year hold.
- Changing assumptions about the purchase price (we used a current market level) or investment performance will, of course, alter these results.
However, this analysis raises the question as to the wisdom of selling via a secondary to enable pie charts and portfolios to be more quickly in sync. The secondary trade is very attractive in dire circumstances to the buyers, who usually leverage the purchase. We are even more bemused when we see investors sell their piece to a buyer in which they are also invested. They lower their “basis” on the future math, but add a second layer of fees and carry on the investment. Perhaps a “Fund of Funds of Funds” strategy for tertiaries wrapped into a CV funded by a NAV loan will solve this. I’m Rob Morris and I approve this blog.