Innovation is in the air for the secondaries market

Last year was a tale of two halves for the secondaries market, with a quiet first six months followed by a significant activity ramp up, particularly among GP-led deals. The year finished out on $60 billion, according to Greenhill figures, lower than 2019’s record of $88 billion, but still the third-most active year on record.

Predictions for this year and beyond are bullish, with forecasts borne out by buyer pipelines – nearly every secondaries fund claims to be busier than ever right now. “A value of $100 billion or more in secondaries transactions for 2021 is a reasonable estimate based on what we’ve seen to date,” says Petra Bukovec, partner in Pantheon’s global secondaries team. “In three years’ time, I wouldn’t be surprised if that had doubled.”

US GPs catch up

And, as the world’s largest private equity market, the US looks set for a significant share of that growth. In 2020, North American secondaries accounted for 56.7 percent of the market’s total volume and $35 billion of the value, according to Setter Capital’s full-year breakdown. And while the most vibrant part of the market currently – GP-led deals – may have flourished earlier in Europe, the US is catching up fast as wrinkles around transparency, process and conflict of interest have been ironed out.

“GP-led deals may have become established a little earlier in Europe, largely because in the US there was an initial perception of conflict,” says Carlo Pirzio-Biroli, chief executive and managing partner of Glendower Capital. “But once status-quo options became part of the framework then US market activity accelerated significantly. As the largest repository of private equity assets globally, the US market still has the scope to grow substantially from here.”

Some of the US’s best-known names have now started embracing the GP-led secondaries market, in particular to hold on to single assets with strong future potential as an alternative to exit. Last year, Clearlake Capital rolled software business Ivanti into a continuation fund, for example, and Thomas H Lee did the same with wealth management business Hightower.

“A value of $100 billion or more in secondaries transactions for 2021 is a reasonable estimate”

Petra Bukovec
Pantheon

“Many fund managers appreciate the flexibility that the secondary market can provide,” says Ben Perl, managing director at Neuberger Berman. “Creating a liquidity option through a continuation fund can be more attractive than selling a well-performing asset that has generated an attractive return to another sponsor who will continue to generate attractive returns and compound value.”

So much so that these deals now account for a large proportion of secondaries players’ time and, according to Setter Capital and Evercore figures, they overtook the LP trade market by volume last year for the first time ever. “There is significant buyer appetite for these deals and growth will continue,” says Tom Kerr, head of secondary investments at Hamilton Lane. “Around 50 percent of our forward calendar of GP-led deals involves single assets.”

Globally, secondaries investors have plenty of dry powder, with around $153 billion waiting for deployment, according to Triago figures. Yet many players say the market is still undercapitalized, especially in the GP-led space. This is leading to the development of a syndication market as buyers seek to manage portfolio concentration issues in some of the largest deals, which is offering some acquirers some attractive opportunities for minimal effort.

“We are seeing post-deal syndication to LPs and smaller buyers in larger GP-led transactions,” says Jeff Keay, managing director at HarbourVest. “This allows those groups to leverage off the work done by a lead or co-lead secondary player without having to do the heavy lifting. There isn’t always enough capital among secondary buyers for the larger GP-led deals, so smaller syndicate players can show up closer to the finish line.”

New players

Given the demand for capital, it is hardly surprising that new entrants are eyeing the market with substantial interest. Ares has recently acquired Landmark to add secondaries investing to its suite of strategies, while others, such as TPG, Brookfield and Macquarie are busy building out secondaries teams.

What will all this mean for the competitive dynamics in the market? GPs having secondaries capabilities is nothing new – after all, The Carlyle Group’s acquisition of AlpInvest back in 2011 brought with it a well-established secondaries business. And for some, GP interest in secondaries is something of an endorsement.

“The arrival of some of the buyout houses in the secondaries space is a great validation of the secondary market as a viable, permanent part of the private equity market,” says Keay. “Some of these new entrants have generated significant success in other investment strategies, and so the fact that they see opportunity in secondaries is a positive sign.”

He also points to the fact that it will be some time before we see the effect on supply and demand in the market since some of the newer players have still to raise capital.

“The US market still has the scope to grow substantially from here”

Carlo Pirzio-Biroli
Glendower Capital

Yet others are less certain about how much of a dent these players will be able to make. While those acquiring whole secondaries businesses may get up to speed quickly and be able to demonstrate some separation from their primary business (given the potential for conflict of interest), those establishing teams from scratch may find the going tougher than expected.

“It can take a significant number of years to build out a secondaries franchise and establish a credible track record, especially if you are bringing together people who haven’t worked together before,” says Pirzio-Biroli. “The acquisition route is clearly faster, but there are fewer and fewer independent groups in the secondaries market with institutional scale.”

Perl adds: “Firms looking to break into this part of the secondary market will need to appreciate and learn the art of GP-led secondary investing – you have to be able to diligence and structure investments as a direct investor, while also knowing how to partner with a fund manager as a limited partner and align interests correctly.”

Lowering the bar?

With so much activity and a lot of buyer interest, some may question whether we will start to see the emergence of lower- quality deals on the market any time soon – post-pandemic dealflow has so far largely been concentrated in covid-proof high-quality assets. “The quality of the assets in the GP-led transactions we’re seeing in the market today are the highest we’ve ever seen,” says Bukovec.

While these may emerge at some point, buyers say there continues to be so much activity with strong GPs involving trophy assets that they can afford to be highly selective. They also say discounts on less-than-stellar assets would be too steep.

“If there is a portfolio or asset where values fall or there are question marks, it would have to trade at a level that is compelling to existing LPs and that might not be attractive for buyers,” says Hamilton Lane’s Kerr. “That provides a natural brake on deals below a certain quality threshold in today’s market.”

Yet some say more complex situations could get some traction in the market in months to come. “Besides the trophy single-asset segment, we also see continuation funds for the remaining assets in eight- to 12-year-old funds, which can at times be trickier and more complex to execute,” says Pirzio-Biroli.

“In all instances, quality of assets and creating true alignment with GPs remains fundamental. There are a lot of opportunities with these characteristics in the mid-market space. I’d also include tail-end portfolios – there are around $500 billion of buyout funds between eight and 10 years old and we will continue to see deals get done here.”

Switching sides

Given the noise and activity around GP-led deals, LP trades have taken something of a back seat. Yet they haven’t disappeared, says Larry Abraham-Ajayi, vice-president at Setter Capital. “The LP position market is still quite vibrant,” he says. “But there are no forced sellers of the kind we saw in the GFC. LPs are opting to use the market strategically – to rebalance portfolios, prune the number of manager relationships they have and, on the buyside, to buy into managers they like or want to establish a relationship with. We are seeing more buyers in this space, particularly among pension funds or family offices that are looking at opportunities to increase their stake with managers they already know.”

And there is scope for further growth in this market, even if not for the fast-paced innovation seen in GP-led deals, as LPs continue to access it to fine-tune their portfolios.
Coller Capital’s recent Barometer found that half of LPs plan to access the fund position secondary market in the next two years, including 20 percent that expect to be active on both buy and sell sides. Their top rationale, according to the survey, is to refocus resources on the best-performing GPs, mentioned by 88 percent.

“Never underestimate the attraction of the fund secondaries segment – some may see it as the less exciting part of the market, but there is still plenty of scope for growth as LPs increasingly take a more active approach to portfolio management,” says Pirzio-Biroli.

“We’re also seeing a weakening of distributions to capital calls, a trend in evidence since 2015. That’s not because distributions have slowed down, but rather because fundraising has picked up so much. As a result, some LPs may be unable to re-up with their high-conviction GPs unless they sell some of their tail-end positions.”

This is precisely what investors like Oregon Public Employees Retirement Fund have been doing in recent times. After partnering with Pathway Capital Management, the pension plan sold $1.5 billion of older private equity fund investments last year in a bid to allocate more to co-investments.

Some are anticipating an uptick in this part of the market later in the year. “We expect to see a rebound in LP positions and are confident in the long-term growth of this part of the market,” says Perl. “It tends to double in size every four to five years and we see the potential for that to happen again, given the size and continued growth of the private markets against the backdrop of what are still low turnover rates.”

The entry of newer investor classes is also likely to boost this end of the secondaries space, adds Bukovec. “The increased participation of high-net-worth individuals, defined contribution vehicles and retail investors in the private markets will drive growth – their greater need for liquidity will increase dealflow in the secondaries market.”

And it’s likely we will see players seek to differentiate themselves by specialising in particular areas or offering specific types of liquidity.

“As the market matures, we will see more segmentation of the market into different specialist areas,” says Bukovec. “We are already seeing some players focus on large, diversified LP portfolios, while others are looking at GP-leds only. We have also seen the growth in some of the niches at the more structured end with funds focused on the preferred equity solutions and NAV-based loans, as well as GP balance sheet funding.”

Overall, the prospects look good for the secondaries space, with rapid growth in the GP-led market and the potential for higher turnover in LP positions than the historical rate of between 1 percent and 2 percent.

As Kerr says: “The secondaries market will grow. We’re only just scratching the surface, even though values and volumes so far this year are off the charts. It has gained momentum and we are seeing participants really get to grips with the optionality secondaries can offer.”

Top five deals of 2020

Here are the standout deals from last year, in no particular order.

Ping An’s strip sale

In this process, which is understood to have been un-intermediated, the asset management and overseas investment arm of China’s Ping An Insurance brought in new third-party investors using the secondaries market. A group of investors led by Montana Capital Partners and Singapore sovereign wealth fund GIC acquired an $875 million strip of assets off the balance sheet of China Ping An Insurance Overseas and used it to seed two PE funds. The deal paves the way for the unit to manage third-party capital – another sign the secondaries market can deliver more than just liquidity to asset owners.

Future Fund’s A$6bn sale

In October, affiliate title PEI asked: is Australia’s Future Fund private equity’s most prescient investor? A subsequent Deep Dive examined the sovereign wealth fund’s timely offloading of A$6 billion ($4.5 billion; €3.7 billion) worth of PE fund stakes in a Greenhill-advised process initiated before the coronavirus pandemic.

“You have no idea what’s coming but you want to make sure you’re positioned well for whatever comes, so we made the decision to lighten our private equity portfolio last year and create some more liquidity for the fund,” said Alicia Gregory, the SWF’s private equity head. “We never would have predicted a pandemic, but if there is any dislocation or wobbles in the market, that liquidity is always the important thing to have up your sleeve. Better to be lucky than smart, as I told someone at the time.”

CPPIB’s mega-sale

Large portfolio sales were something of a rarity last year. One seller who managed to get a deal across the line – and a large one at that – was Canada Pension Plan Investment Board, which offloaded around $2.5 billion-worth of PE fund interests. The deal was notable in that it was one of the only LP sales to launch and close during the pandemic. Buyers included Goldman Sachs Asset Management and GIC, according to sources familiar with the matter, and the PJT Park Hill-intermediated deal ranks among the largest portfolio sales of all time.

Clearlake’s single-asset deal on Ivanti

The GP-led market for single-asset processes became “frenetic” in H2 2020, according to one market source. One deal that typified this was Clearlake Capital’s process to move software company Ivanti out of several older funds into a continuation vehicle. The deal, on which Evercore and Credit Suisse are understood to have advised, totaled around $1.25 billion. The deal was notable for the speed at which buyers lined up to bid on it, including leads Goldman Sachs Asset Management, ICG and Landmark Partners.

HarbourVest backs DeVos family office liquidity process

The DeVos family office launched a secondaries process with advisor Evercore to sell between $1 billion and $2 billion of PE fund stakes. HarbourVest Partners is understood to have led the transaction, providing $1 billion of a total $1.5 billion on a preferred equity basis. Betsy DeVos, former US education secretary, had expressed her intention to the Department of Education in 2017 to divest her interests in 102 entities to avoid conflicts of interest.