This article is sponsored by Hollyport Capital.
Hollyport Capital is a secondaries investor based in London and New York with over $2 billion in assets under management. Founded in 2007 and currently investing its seventh fund, the firm specializes in the acquisition of legacy private equity assets in the secondaries market. Hollyport managing partner John Carter says that the key to the firm’s success lies in a consistent focus on a specific sub-sector of the broader secondaries market where vendors are seeking to rationalize portfolios that are beyond their original term.
Secondaries funds have historically been seen as opportunistic acquirers of illiquid assets – to what extent is the market becoming more specialized, and how is this likely to evolve with increased competition?
The secondaries market has come a long way over the last 30 years. At the outset, it was a small market in which fund interests were typically acquired at substantial discounts, which in turn enabled secondaries funds to generate very attractive returns. As this market has grown and matured, greater competition has seen discounts narrow, with many highly regarded funds now trading at a premium on the secondaries market.
There is still the opportunity to buy some assets at significant discounts, but this tends to be reflective of perceived poor quality or assets that are little known. In general, there is healthy competition for the vast majority of assets traded on the secondaries market, and this has forced buyers to be more focused and selective in the assets that they seek to acquire. Greater levels of specialization are an inevitable consequence of this trend, and we can expect this to continue, both in the traditional acquisition of LP interests, and particularly in the growing market of GP-led fund restructurings which involve a far greater concentration of assets.
You mention the need for specialization – how would you describe your strategy in this context?
Hollyport is a specialist legacy secondaries investor. We seek to provide complete solutions to longstanding institutional investors in the asset class that wish to rationalize their tail end assets. A typical situation would include multiple funds interests, all beyond their originally intended term, comprising hundreds of underlying company investments across a wide range of geographies and sectors. Inevitably, these remaining assets will be of mixed quality.
“The past performance of the company is less important than the future proceeds it
The challenge for us is to assess each individual company in every fund, and to form a view on when it will be sold and for what price. We then compare this potential exit price to the current holding value to determine the relative attractiveness of the asset. Over the whole portfolio we can therefore identify the assets that will be accretive to current valuations compared to those that are more likely to erode value. This enables us to price the portfolio in its entirety and offer a complete solution to the vendor.
By focusing on these legacy fund interests, don’t you just end up with the poor-quality businesses that are left after all the good companies have been sold?
That is a good question reflecting a quite widely held belief.
When we are conducting our analysis of a legacy asset portfolio, we look at the merit of each underlying company as it is valued today. We are not particularly concerned with the past performance of the company, if it is in a top quartile fund or a bottom quartile fund, or the perceived attributes of the fund manager.
From our perspective, a good asset is one that is conservatively valued compared to the price that it will achieve when sold, with an engaged GP who has a clear and realistic near-term exit plan for the asset. The past performance of the company is less important than the future proceeds it can deliver.
You mentioned that a single portfolio can comprise hundreds of underlying company investments. How do you diligence these assets?
When appraising portfolios of LP fund interests, you can adopt either a ‘top down’ or ‘bottom up’ approach. Our strategy is very firmly the latter.
When we analyze a portfolio, we form our own view on the realization value and timescale for every asset in every fund. This is a resource intensive process but is reflected in the fact we have a team of over 20 investment executives across our offices in London and New York. We also benefit from the fact that we hold investments in over 1,000 funds. This gives us a valuable database of prior performance which enables us to diligence a wide range of assets with a high degree of confidence.
We all know that the secondaries market is becoming increasingly competitive – is it possible to differentiate yourself on anything other than price?
Most sellers of legacy assets have a clear picture of what they are seeking to achieve and want a clean and efficient process that delivers their strategic objectives. This is particularly the case for portfolios containing a significant number of fund interests, for which each transfer requires a separate legal agreement between the buyer, seller and GP of the underlying fund. The sale process is therefore quite complex, and consequently such vendors have a strong preference for engaging with counterparties that they know and trust.
“A good asset is one that is conservatively valued compared to the price that it will achieve
Some GPs have a small list of approved acquirers for secondary transfers, and this can provide some advantage to those on the approved list. More importantly, as a replacement investor in a fund, the GP will want to know that the secondaries acquirer is going to be supportive of their value realization strategy. Market reputation is therefore an important factor.
Hollyport is invested with over 600 GPs globally, and has completed over 100 secondaries portfolio acquisitions, including with many of the largest global investors in private equity. These relationships enable us to work on transactions as a preferred counterparty.
Are most secondary transactions intermediated, or is there any ability to source proprietary dealflow?
The majority of secondaries transactions are intermediated, and we work with all of the key advisors active in this market. Alongside this, Hollyport has a global direct outreach program to originate new dealflow and we source approximately a quarter of our transactions from these activities. Working directly with the seller and the GP can enable us to tailor solutions that meet specific objectives of the parties, and in doing so generate significant added value. This is particularly the case with GP-led fund restructurings, which are typically complex transactions to execute.
What longer-term trends do you see in the secondary market, and how are you going to continue to deliver performance in an increasingly competitive environment?
The biggest current area of growth is GP led transactions, with many new entrants focused on these opportunities driving the market forward. It is a rapidly evolving market, and there are likely to be winners and losers. We are both cautious and disciplined in our approach to these transactions.
In a competitive market, I believe it is important to be consistent in your investment strategy, focusing on areas where you have key, sustainable competitive strengths. In the first quarter of this year, we saw more than 100 transactions, worth more than $4 billion, so there is no shortage of opportunity. The challenge is to focus on the opportunities where we like the deal dynamics, be rigorous in our due diligence and disciplined on pricing.
It is an exciting time to be investing in the secondary market, with the opportunity for top performing managers to continue to deliver highly attractive returns to their investors.
GP-led transactions are a growing part of the secondaries market. How do you believe this segment will evolve?
GP-led transactions have grown significantly over the last year, and in 2020 accounted for over 50 percent of the market. Talking to most market participants, this trend is likely to continue and be a major factor in the overall market growing to over $100 billion per annum. But it is important to recognize the challenges with these transactions.
The GP needs to work with prospective secondaries investors to provide appropriate information to facilitate due diligence. At the same time, the GP has fiduciary responsibilities to existing investors to both maximize the realized value of investments, and to enable them to make an informed choice on whether to accept an offer of liquidity. These are not easy processes to manage, and best practice in the industry is still evolving. At the moment, a significant number of these potential transactions are failing to proceed for these practical reasons.
Hollyport completed its first GP-led fund restructuring in 2007. There was just one asset left in a 14-year-old fund: a British business called Sauflon Pharmaceuticals, which manufactured contact lenses.
The GP said: “I need a solution for this business. It has some interesting technology, but the company needs more money to build it out.” We met the management team and spent a great deal of time looking at the business; we liked it. We then raised mezzanine finance for the company to expand; this included building a new production facility in Hungary. Over the next seven years profits grew from £1 million ($1.3 million; €1.1 million) to £25 million before it was sold to CooperVision, who were keen to acquire its silicone hydrogel lens technology. Through the sale, we achieved a 58x money multiple for our investors.
We have subsequently completed over 30 GP led transactions, and it now represents approximately 30 percent of our investment activities. We see it as a valuable complement to our legacy LP portfolio acquisitions.