In December, the founder and managing partner of Thoma Bravo, Orlando Bravo, tweeted: “Liquidity is overrated.” He argued, if you have conviction in a manager or a business, why place so much value in being able to sell at any time? While Bravo makes a good point, liquidity remains important – particularly to private wealth investors.
In January 2021, when Moonfare signed an agreement with Lexington Partners that made the secondaries buyer the chosen provider of liquidity for the platform, Moonfare’s founder and chief executive Steffen Pauls said: “We listened to the market… Illiquidity was one of the main concerns left standing between individual investors and allocations to private equity.”
Why has liquidity been hard to come by in the past? And how is this changing?
For secondaries funds, individual investors have typically been unattractive counterparties. The cost of carrying out price discovery and executing a deal are rarely worth it given the small size of stakes that tend to trade. Intermediaries have proved reluctant to get out of bed for such deals as their compensation is linked to the amount of net asset value that changes hands.
“There are guys who do [buy from private wealth clients], but they are tiny and you need to work with the banks and private wealth providers to find ways of structuring those deals,” said a managing director from a non-traditional buyer around the time of Moonfare’s Lexington tie-up.
Proportion of potential client assets globally that come from individual assets, according to Scott Nuttall, co-president of KKR
Value of these potential assets…
…proportion of which is invested in alternatives
Even if the deal is big enough, the dynamics have often floundered due to differing priorities. While stake trading platforms have worked to abridge and standardise documentation to encourage transfer activity, smaller secondaries buyers derive upside from careful structuring and robust negotiation.
“[Trading platform] Nasdaq tried to standardise so there would be one transfer doc and if you agreed to buy something on the exchange, nobody could negotiate the transfer doc at all… It didn’t really pay off from an execution standpoint,” says one managing director with an East Coast secondaries firm.
The provision of liquidity to private wealth investors has regathered momentum in recent years as the size of the opportunity got too big to ignore. According to Scott Nuttall, co-chief executive of KKR, 64 percent – or $179 trillion – of potential client assets in the world comes from individual investors, yet less than 5 percent of this is invested in alternatives.
The Beneficient Company Group, a Texas-headquartered liquidity provider, estimates there is $40 billion of annual demand for liquidity from high-net-worth individuals and small institutions that want to offload private assets, global head of originations and distribution Jeff Welday tells Private Equity International.
Different service providers are taking different approaches. Beneficient uses its balance sheet to buy illiquid assets from private wealth customers, dealing directly with a network of individual investors, private banks, broker-dealers, estate planners and tax accountants. Frictional costs are kept down by using standardised documentation and the firm’s own trading technology.
“When we provide liquidity to a seller, our intention is to hold that interest through to maturity and exit,” says Welday. “We’re not looking to create a secondary marketplace for those interests.”
Beneficient also offers liquidity on platforms developed by others. In October, affiliate title Secondaries Investor reported the firm was to be the initial liquidity provider for Liquidly, a New York-based alternatives trading platform founded in 2018 by former Goldman Sachs trader Anusha Harid-Paoletti. Liquidly will initially try to lure private bank feeder funds, through which many individuals access private equity, in order to generate the larger transaction sizes that appeal to institutional buyers.
“You could boil down our efforts for
the secondary market into one word – access.”
Liquidly’s seed investor is Village Global, an early-stage venture firm backed by a network of entrepreneurs, including Jeff Bezos and Bill Gates. Liquidly’s “sophisticated trading technology, rigorous regulatory and compliance features, and an exceptional user experience” were among its most attractive features, said Village Global co-founder Adam Corey last year.
Moonfare has also focused on increasing ticket sizes. Investors can sell their fund stakes to Lexington and other investors on the platform through a digital bidding round held twice a year. These liquidity windows allow it to aggregate the orders of multiple investors into larger chunks.
The platform benefits from being exposed to a fixed list of 42 funds, whose GPs are all willing to have Lexington as an LP. In an open market, transfer restrictions can always scupper trades.
Small is beautiful
Paris-headquartered Palico takes a different approach, focusing on small trades that intermediaries don’t generally want to deal with. It aims to streamline the administrative and bidding process to the extent that transfers of less than $20 million can be sold in a commoditised fashion.
“You could boil down our efforts for the secondary market into one word – access. Access to the secondary process, to secondary buyers, and to liquidity for PE fund stakes that traditionally didn’t have the size to be marketable,” said Palico chief executive Julien Gervaz in a 2020 article.
For all the businesses that have entered this space, traded volumes from private wealth clients are still a drop in the ocean. Some GPs will remain picky about who can buy into their funds, and some secondaries buyers will continue to fight against the standardisation of the transfer process in order to maintain what they see as an edge.
Providing liquidity and a trading platform versus just a platform, trying to create larger tickets versus focusing on small ones, dealing directly with investors versus dealing with private banks – there are lots of approaches being tried, and it will take time to see which come out on top. The direction of travel, however, appears to be one way.
– This report has been updated to correct Scott Nuttall’s title as co-chief executive of KKR.