Mike Catts, partner at Hollyport Capital, on the legacy opportunity in secondaries

Hollyport closed its eighth flagship fund, along with its first-ever co-investment vehicle, at the end of 2022 on more than $2.2bn.

Mike Catts, Hollyport Capital

Mike Catts, a partner at Hollyport Capital, spent some time chatting with Buyouts about legacy secondary sales, the rise of GP-led opportunities, including those in the legacy space, and how recruiting has changed over the years.

Hollyport closed its eighth flagship fund, along with its first-ever co-investment vehicle, at the end of 2022 on more than $2.2 billion.

How has the market performed so far this year?

It’s been pretty good out of the gate. We’ve seen a number of large trades in the legacy space come to market, and you have this dynamic where there’s still a lot of pent-up supply despite pretty healthy transaction volumes.

Last year, LP volume was around the peak, but if you look at the broader private markets, liquidity has been pretty weak overall. M&A volumes are down over 50 percent and the IPO market is down over 80 percent from its peak. And so, the secondary market is a bright spot for liquidity for LPs. With this being said, there has been a bit of a bid/ask spread over the past couple years. It’s starting to narrow, and that’s why volume has increased, but I do think that LPs remain heavily over-allocated to private markets, and the set-up for further growth in the LP space this year is very good.

Overall, as pricing ticks up and the distribution environment improves, people will underwrite with more confidence and we’ll see increased volume in the secondary market.

We also expect to see more and more mid-market sponsors starting to learn about their liquidity options in this market, which will lead to an increase in the number of opportunities in this part of the market.

The intermediaries are driving this because they want to find deals that have less execution and ultimately syndication risk. Doing a deal that’s a little bit smaller, where a couple of buyers can team up and speak for the whole deal is attractive for them from an execution perspective.

That creates opportunities for Hollyport. We’re more of a mid-sized player in the market so there’ll be more deals that are in our wheelhouse.

What does increased activity mean for legacy secondaries?

There is a lot of pent-up supply in funds of funds and even secondary managers looking to wind down 10-plus-year-old vehicles.

The AUM in the legacy space is about 5x what it was 10 years ago, so right now if you look at 10-plus year-old funds, the total AUM is approaching $1 trillion. We’re pretty excited about the short, medium and long-term prospects for our business.

The average private equity fund currently lasts about 15 years while being structured as 10, 12-year vehicles, so they’re taking longer to liquidate. The overall AUM in private equity has grown rapidly. In addition to that, liquidity has been down over the last few years, so the opportunity in the legacy space is growing faster than the broader private markets.

In the legacy space, there are a lot of buyers who are going to be sellers this year as they have been waiting to execute a trade in a more attractive pricing environment. Also, the large pensions have been starting to come off the sidelines as pricing improves and optical discounts have reached a level that’s acceptable for them to trade.

GP-led activity was mixed last year, ending the year strongly. How is such activity shaping up this year?

The GP-led market has grown rapidly, around 10x what it was 10 years ago. A lot of those trades happened in the last five years or so. In terms of relevance to the broader industry, the GP-led space represented 12 percent of sponsor-backed exits last year, which is up from 4 percent in 2019.

You can see that more and more people are becoming educated about this space and understanding that it’s a good alternative for liquidity in a challenged exit environment. At the same time, we’re in the early innings of development of this market and there are a lot of GPs not familiar with their alternatives. That’s going to change over time. The growth opportunity in the GP-led space is pretty immense.

In addition to that, capital formation on the buy side has been good, but it’s still early days. The data for deals done in the last five years is developing and we’re starting to see strong returns. As investors start to see the return potential, more money will flow into the space and sponsors will be excited to access this alternative source of liquidity.

Many LPs have mixed feelings about continuation fund deals. How might this change over time?

LPs vote with their dollars and 80 to 90 percent of them choose to sell when given the option because they value liquidity at this moment. I think that as people see more of these trades, they will set up processes in-house to address their concerns. The options are ultimately just: sell if you choose to or roll and continue. If properly structured, you’re not forcing someone to do something they don’t want to do.

What is your growth outlook for Hollyport?

We just moved to a new office space at 52nd and Lexington with room for over 30 professionals, which demonstrates our intention to continue expanding in the US. By the end of next quarter, we should have about 16 professionals in New York, including Andrew Ward, who is currently based in London. Andrew is a dedicated GP-led principal at Hollyport and he will continue to focus on that part of the market over here in New York.

At this point we have a pretty deep bench of mid-level people that have been with us for five, six years. That’s how Hollyport has built its teams historically. If you look at the partnership, the majority of partners were entry level new joiners.

Where do you look for new talent?

We’ve historically hired a lot of people with accounting backgrounds as they are particularly well suited to underwrite LP and GP trades. We want smart, humble people that are intellectually curious, those are the types of people that do really well in this industry.

To riff on recruiting, when I started doing secondaries over 15 years ago, you almost had to convince people to join. You had to explain what secondaries was and sell the market opportunity; it almost felt as though they were taking a career bet on our little niche market. A lot of people kind of fell into secondaries during that time, including a lot of people that are leading businesses in secondaries today.

Today our recruits are much more aware of the market and the opportunities. We’re even seeing resumes come across from traditional buyout shops where there has been some disruption, capital raising issues, and changes in human capital needs. I think that people recognize that the secondaries market is a great place to have a career in a way that they didn’t 15 to 20 years ago.