Fort Washington: A holistic approach to secondaries

This article is sponsored by Fort Washington Capital Partners

How has secondaries dealflow evolved over recent months and years?

Rob Maeder: We first started out investing in traditional LP secondaries back in 2003. We were also early movers in the GP-led space, completing our first deal in 2008. So, we have been participating in the market for a long time.

The industry has evolved significantly in the past two decades. Most notably, the GP-led market has grown dramatically, particularly in the past two years since covid struck. Sponsors were looking for creative solutions for their portfolios through the pandemic, which accelerated adoption of the GP-led approach, with deals increasingly focused around high quality managers and their star investments. This evolution has definitely played to our strengths, because we are not just secondaries investors, we are primary investors as well. Our GP network is an important resource for us in terms of deal sourcing and access to information.

Steve Baker: As Rob said, GP-led secondaries originated from a need to provide solutions to GPs in the wake of the financial crisis. The GP-led transactions we are seeing today, however, involve the trophy assets that top tier managers really want to hold on to. It is a further institutionalization of the GP-led market.

Why do you think it is important to have exposure to both GP and LP-led secondaries in a portfolio?

SB: I wouldn’t say that the market is that binary. There are GP-led deals. There are traditional LP-led deals. But there are also tender offers and strip sales, for example, that fall in between. We believe that a secondaries investor needs to view the market holistically, and our experience of conducting due diligence at both the underlying portfolio company and GP level puts us in a good position to assess the risk/reward attributes of all of these different transactions. Sometimes a deal may even start out as a traditional secondaries transaction but end up as a GP-led transaction. It is important not to confine yourself to one camp or the other.

RM: I completely agree. There are firms that choose to focus on either GP- or LP-leds, but we feel there is a great deal in common between the two. You need to have a view on the underlying portfolio companies. You need to have a view on the manager. And you need to understand the economics and alignment.

We focus on the process itself, particularly with regards to access to information. Sometimes a process is run in such a way that you have the time to conduct all the diligence you need, and the access to the sponsor and underlying management teams required to make that happen.

At other times, timelines are compressed, and access is limited. Obviously, we would require transparency and access as much as possible. These issues around process are more important to us than the structural differences between traditional LP secondaries and GP-leds.

How would you describe competitive dynamics in the secondaries market today, and how do you differentiate yourselves?

SB: The market is very competitive today. We are differentiated in an industry dominated by mega-funds, in that we are a small manager investing in small funds, which enables us to play below the radar. Although we operate at the smaller end of the spectrum, we bring a highly experienced and sophisticated team to these situations.

RM: I would emphasize again our ability to flex between traditional LP secondaries and GP-leds. I would also reiterate the importance of our primary network, which can allow us to identify deals that we might not otherwise see. It is not uncommon for us to hear about a deal coming together from the GP themselves, as opposed to an investment banker. That gives us the advantage of time to get up to speed.

Our primary relationships are also extremely useful when it comes to diligence. We principally invest with industry specialist managers that have deep expertise in their respective sectors. We can tap into that expertise if we need insight into a particular market, allowing us to either decline a deal or build conviction.

How would you describe supply/demand fundamentals in the secondaries industry from a fundraising perspective?

SB: Two years ago, secondaries fundraising hit extraordinary heights, with close to $90 billion of capital flowing into the asset class, compared to $20 billion to $30 billion in a typical year. So, I think we may see a bit of an overhang, particularly at the larger end. But I ultimately think this will pass and that we will return to historical fundraising norms.  Although a lot of money has been raised, dealflow is also abundant, and I do think the capital will be deployed.

“We believe that a secondaries investor needs to view the market holistically”
Steve Baker

RM: I agree that the situation is not as challenging as it may look from the outside. Certainly, a lot of money has been raised, but that fundraising activity has opened up the GP-led opportunity set. A market that was niche a few years ago is now routinely being considered as a portfolio management tool, as GPs get creative about how to engage with the secondaries industry for the benefit of their LPs.

What do you think the prospects are for secondaries returns in light of all this new money flowing into the asset class?

SB: I don’t think it is as simple as saying that lots of capital equates to lower returns. The biggest determinants of returns are the price you pay for an asset and the price you sell it for. Public markets are currently robust, and fundraising for direct investors is strong. In that context, I think you can expect returns to remain solid. If we do end up operating in a more challenging economy, however, returns may suffer because of the implications for the exit environment.

RM: Our underwriting hasn’t changed. We are still underwriting to the same returns, on an unlevered basis, as we have done since inception of the program. But we are having to review more and more opportunities and be increasingly selective in order to achieve those results.

If we do experience a significant market correction, what would that mean for dealflow in both the GP- and LP-led space?

RM: I think GPs might look for ways to postpone selling their portfolio companies, as they wait for a more favorable exit environment. That could potentially make for a very exciting secondaries opportunity.

SB: I think it could also create opportunities on the LP side. LP dealflow was slow in 2020 because the market correction was short-lived. But if we were to enter into a more protracted downturn, investors might find themselves facing the denominator effect. If the overall portfolio loses value, they may have to sell private assets in order to rebalance.

If the cycle turns, I think it could make for a very interesting environment for secondaries buyers.