Carlyle AlpInvest on the importance of selectivity in today’s market

Continued volatility is bringing many opportunities for secondaries players. The biggest risk is spreading yourself too thin, says Carlyle AlpInvest’s global head of secondaries, Chris Perriello.

This article is sponsored by Carlyle AlpInvest.

The volatility we saw in 2022 has continued into this year. Is that creating opportunities for the secondaries market?

Chris Perriello

We have been swimming uphill for a long time, as we are essentially an industry that can thrive in times of volatility that has been operating in a very non-volatile market for a decade. So, it has been a different challenge in the past 10 years, where things have worked, but creating opportunities and finding value has been a challenge. Entering the back half of 2022, when we started to see some volatility in the markets, while not positive generally, as a buyer you could see new and different opportunities coming your way. 

Right now, we have seen that liquidity has a meaningful premium attached to it because GPs are trying to create liquidity at their fund levels and LPs in some parts of the world are dealing with the impact of the public market decline on their private equity allocations. 

What are some of the challenges buyers are facing?

As a buyer, market volatility impacts our view on pricing assets. Over the back half of 2022 and the first half of 2023 we saw a bit of a pause around buyers acknowledging a tremendous opportunity set out there, but there was a disconnect around willingness to transact at volume because of the element of volatility around pricing. 

Volume came down during that period, but that was from an execution perspective. If you look at the pipeline of what’s building, the number is significant, both in the LP market, and the number of GPs wanting to do a GP-centered deal that are waiting for the right price point or the right time. We are starting to see a convergence of that bid-ask spread, but it’s still coming, as opposed to happening in real time. Buyers are being a little more cautious.

Are you seeing more opportunities in the LP-led market or the GP-led market?

Historically, we are about 60-40 weighted, so we are a pretty balanced all-weather investor. Our take has always been that there are better opportunities in different cycles to participate in one market or the other in a more outsized way. So, you will see we went slightly heavier in the GP-centered side over the past five or six years when we thought the market was a little overbought and expensive on the traditional side. The counter to that would be, as we think about the next one to three years, we do see an opportunity on the LP interest side as underlying valuations have come down. There’s less leverage in the system for our competitors to use as buyers. There’s a more rational market. 

The secondaries market is an increasingly wide umbrella for different types of transactions and deal structures. How do you think about that with regards to portfolio construction?

For us, it’s matching the expected return of capital to the right type of opportunity from the investor experience side. And then it’s being able to provide the full suite of solutions to our GP and LP partners. We have kept the Secondaries and Portfolio Finance team integrated, with the logic being sourcing GP relationships and being a solution provider to our GPs and to our LP partners comes from the same team and the same relationships. You should show up and be able to provide that solution as an organization, as a team. 

But they are different return profiles, so we segregated the portfolios. You have a more traditional private equity return profile in the secondaries world and more of a credit-oriented risk-return profile now that portfolio finance has developed. Our perspective is to match the capital with that and to leverage the power of the integrated team.

What opportunities are you seeing on the portfolio finance side? 

We participate in a variety of types of transactions. If you bucket them into three broad categories, it will be: fund financing opportunities, GP financing opportunities and LP interest financing opportunities. They are developing at a slightly different pace and people are attacking that market in different ways. Our approach has been to offer solutions spanning all of these and be a provider for both our LP community and our GPs. 

We spend a decent amount of time on the fund financing and GP financing side of the business, across the board, given our deep relationships with the GP community. We do some traditional LP interests on the credit side. We will continue to do that, but it’s a smaller piece of the portfolio’s profile. We have done several LP interest financing deals as well. There’s size and scale to be done there, but it’s still an evolving market in terms of types of solutions which presents an opportunity for further market growth.

How do you see this part of the market developing over the medium-term?

Our guess is about $14 billion in volume occurred in 2022 on the portfolio finance side. We can see the market over 2024-26 reaching to about $50 billion to $70 billion, with $60 billion to $65 billion of that being fund financing, GP financing and LP interest financing, and $5 billion to $10 billion being credit secondaries. 

What do you see as being the key drivers of growth for the secondaries market over the next five years?

We estimate that about 30 percent of the GPs have done a GP-centered deal, so there are 70 percent that have not even touched the market yet. With that influx of GPs entering the market will come more traditional GP-centered deals that you are seeing today, and likely more ideas around new types of deals. 

On the portfolio finance side, we are really just touching the tip of the iceberg there in terms of all three of the segments. As GPs continue to become more sophisticated around how they manage their business, there will continue to be more financing options we can provide. We haven’t seen a lot of LPs doing a recapitalization or refinancing of their own portfolio. It has happened, but not at scale. If those continue to create hold on that market, you are going to see volume there. 

The LP market continues to grow fairly steadily, driven primarily by overall PE fundraising looking back three to five years in conjunction with the churn rate on that NAV that trades in the secondary market trending towards 2.5-3.0 percent. The GP-centered market has seen a very positive secular trend over the past decade with tailwinds that continue, and has a long way to go from a growth perspective. That will come with new types of transactions, new structures.

With so many challenges for GPs around exits right now, more are turning to the GP-led market for a solution. Does that mean you need to be more discerning as you’re evaluating potential transactions?

There needs to be a value creation thesis for a continuation fund. Why are we doing this? What’s our value creation? What are we underwriting? Rarely is it only, ‘I just need more time.’ 

With the exit markets being extremely tight today, that is sometimes the case. People are just looking for more time or creating a liquidity option when there isn’t one. For us today, both on the LP side and the GP side, the challenge is picking your spots and really being selective. The luxury is, with only about a year’s worth of capital in the system, a buyer can be selective. 

To make or break this next fund cycle, buyers need to ask themselves: “Did we take the funnel, narrow it down based on our criteria that we are good at and select the right opportunities based on that?” Because there will likely be plenty of opportunities. I don’t think supply is going to be a problem. 

Our challenge as investors is making sure we dedicate resources toward the right place. We want the funnel to be as large as possible, we want to see everything, and then we want to have a pretty good method to narrow down where we are going to assign deal teams and dig in. What are the dynamics of the deal? What competitive advantage do we have? What’s the underwriting thesis from a value creation perspective? 

The biggest risk in this environment is spreading yourself too thin, trying to attack everything. You have to pick your spots based on what’s available, and what you think you are bringing to the table as a buyer.