For 15 months during the pandemic, the GP-led secondaries market seemed like the only game in town. Market volatility made it difficult for buyers to price diversified portfolios, causing them to turn en masse to concentrated deals.
Just when you thought the LP market was down and out, it rose from the canvas. From the third quarter of 2021, a succession of $1-billion-plus portfolios began coming to market from names such as Harvard Management Company and Northwestern Mutual, continuing into 2022. GP-led deals ended up accounting for 52 percent of deal volume in 2021, while at the year’s halfway point, they accounted for 60 percent, according to Jefferies.
For years, LP-led deals formed the backbone of the secondaries market. The pandemic-fuelled growth of the GP-led market briefly brought this into question. Will LP portfolio deals be the bread and butter of secondaries in five years’ time? Here are some predictions.
1. LP-led activity to remain unpredictable
The stars aligned to produce last year’s impressive recovery: valuations stabilised, buyers had plenty of dry powder, and the outperformance of private equity drove up pricing and compelled LPs to sell portfolios in order to free up capital for reinvestment.
This momentum was maintained until February, when Russia’s invasion of Ukraine stoked fears around the impact of inflation and rising interest rates. This caused public markets to drop, drove a wedge between the expectations of secondaries buyers and sellers, and led LPs to pull deals or transact at lower-than-intended volumes. It showed just how easy it is for volatility to hurt the LP secondaries market, perhaps in contrast to the GP-led.
“The growth of the GP-led space is driven by a set of motivations and incentives that are going to be there year after year,” says Jeffrey Keay, a managing director at HarbourVest Partners. “There’s a higher level of visibility and predictability on that growth because general partners are now viewing the GP-led space as a viable alternative to traditional exit paths… I think there’s a strong case to be made that growth in the GP-led space will be more of a straight line up and to the right than the LP-led market.”
2. Specialised LP-led funds to re-emerge
While there are certainly funds that lean much more heavily towards LP-led deals, it has become difficult to find funds that eschew GP-led deals altogether. Even Ardian, known for its levered index approach to investing, will back GP-led deals with GPs it knows well, such as New Mountain Capital.
Year-on-year growth in LP secondaries transaction volume, 2021
Source: Jefferies Global Secondary Market Review
This could well change, says Oliver Gardey, head of private equity fund investments at Intermediate Capital Group. In 2020, ICG defied the gravitational pull towards the GP-led market by launching a fund dedicated to LP stakes. The firm is banking on the secondaries market having grown enough that specialisation, whether on the LP- or GP-led side, becomes a requirement from investors.
“If you’re investing in a commingled fund with all kinds of secondaries deal [types], you can’t really understand what your exposure is and what kind of a risk profile you have,” Gardey says. “It’s easier for the limited partner to allocate to the kind of secondaries they want in their portfolio or the mix when you have clear specialisations and clear profiles.”
3. LP market will be increasingly used as a business development tool
In 2017, Manulife and Mubadala Capital used the secondaries market to build a third-party asset base. While the details differ, both deals involved a portfolio of private capital stakes being acquired from the balance sheets of the respective firms and placed into a third-party vehicle backed by new limited partners. HSBC, Churchill Asset Management and MetLife are among the firms to have followed suit.
“I think there’s going to be many different ways to further integrate data into evaluating opportunities”
The drivers behind these deals have only grown stronger. Listed managers, particularly insurers, are under pressure to increase their assets under management and introduce new business lines based on steady, predictable fee streams. At the same time, a fierce fundraising market makes it very difficult for them to raise blind pool private equity funds. It will become increasingly common for asset managers to seed their debut funds using LP-led deals.
“You are competing against traditional funds of funds that have been [fundraising] for 20 years, and it’s tough,” says David Perrin, a partner at Campbell Lutyens. “If you put in a portfolio of high-quality assets, all of a sudden you can take what might be a 24-month fundraise and do it in seven to eight months. Then you are suddenly back on Fund II within two years.”
4. Data analytics to separate the best from the rest
While the secondaries market has grown and developed, the humble spreadsheet has remained its bedrock. Competitive advantage has come from having data, allowing the buyer to quickly formulate the perfect price for a portfolio.
This is unlikely to be enough in the future, says Keay of HarbourVest. Today, the process of inputting the data and choosing which subsets are most relevant to price discovery is largely manual. The software already exists to automate a lot of the bottom-up analysis, allowing humans to focus on what the model says, rather than putting it together.
“Whether it’s isolating the performance of certain industries, certain general partners, certain individuals, I think there’s going to be many different ways to further integrate data into evaluating opportunities,” says Keay. “Right now the building blocks are out there, but more advanced ways of using data aren’t necessarily being applied on a comprehensive and systematic basis.”
5. LP market discretion to play central role in the race to $2trn
There have been many eye-opening predictions about the growth of the secondaries market. Perhaps the most eye-opening is from Vincent Gombault, the former fund of funds head at Ardian, who expects transaction volumes to be as high as $2 trillion by 2030, driven by the overall growth of private assets under management and an increase in secondaries market churn.
A key component will be the discretion afforded by the LP-led market, he said. Sellers can offload large portfolios without the publicity and market reverberations of a public share sale, making it a preferable path to liquidity.
“I envisage a scenario in which the secondary market becomes the most efficient and discrete tool for large investors to move $10 billion-$15 billion mega-portfolios in a matter of months… At this scale, the expected deal volume in 2021 could be achieved in only 10 transactions,” Gombault said.