Side Letter: Sequoia’s bid to reinvent long-holds; Ares earnings; Banking on Japanese secondaries

Venture capital giant Sequoia is undergoing a major restructuring as it embraces longer holds. Plus: What you need to know from Ares' Q3 earnings and why two Japan veterans are banking on the country's secondaries market. Here's today's brief, for our valued subscribers only.

They said it

“None of this is to play down the risk of private assets — they are harder to value, less liquid and require greater due diligence than their public counterparts. Nevertheless, their sheer heft means that arguments for opening them up to non-professional investors deserve a fair hearing.”

Vincenzo Pelosi, head of investment communications at Pictet Asset Management, makes the case for retail access to private equity in a letter to the Financial Times (paywall).

Just happened

Sequoia goes long
Whether through dedicated funds, rollover co-investments or continuation vehicles, private equity firms the world over are increasingly seeking to hold onto prized assets for longer. Sequoia Capital – the world’s fourth largest VC firm (according to a ranking by affiliate title Venture Capital Journal) – has gone a step further. The firm said this week it would break with tradition and restructure its US and Europe business around a single, permanent structure.

“Moving forward, our LPs will invest into The Sequoia Fund, an open-ended liquid portfolio made up of public positions in a selection of our enduring companies,” it said in a statement. “The Sequoia Fund will in turn allocate capital to a series of closed-end sub funds for venture investments at every stage from inception to IPO. Proceeds from these venture investments will flow back into The Sequoia Fund in a continuous feedback loop. Investments will no longer have ‘expiration dates’.”

Sequoia certainly isn’t the first VC firm to dabble with novel ways of retaining assets. Insight Partners, the world’s largest player in this sector, is seeking $1.25 billion for a follow-on fund specifically to extend its ownership of certain existing portfolio companies. The UK’s Forward Partners folded its portfolio onto its balance sheet in July and listed as an investment company so it could invest in an open-ended fashion.

There are some questions over how exactly Sequoia’s new vehicle will work. Alan Feld, co-founder of Israeli fund of funds manager Vintage Investment Partners, raised several of them in a LinkedIn comment, including how the GP will be compensated if all capital is reinvested, whether LPs will be able to sell on the secondaries market, and how much of the permanent capital would be stumped up by the firm itself.

Still, that such an established and well-respected manager is willing to completely overhaul its operations to prioritise longer holds suggests this is anything but a short-term fad. While few managers are unlikely to do anything as dramatic as Sequoia any time soon, expect innovation in this area to continue.

Ares-onable quarter
Ares Management is the latest PE blue-chip to report its Q3 earnings. Here’s what you need to know from yesterday’s results:

  • The firm collected $2.2 billion for the asset class in the period, including $1.5 billion for Ares Corporate Opportunities Fund VI, which now has $5.7 billion of commitments.
  • It raised an additional $1.1 billion for PE secondaries.
  • Ares deployed $1.7 billion in Q3, including $900 million into corporate PE and $700 million into special opportunities. It also deployed $0.6 billion into secondaries, half of which was for PE.
  • Its 2017-vintage ACOF V had generated a 1.3x net MOIC and 10.8 percent net IRR as of end-September. The 2019-vintage Ares Special Opportunities Fund was running at a 1.6x net MOIC and 50.3 percent net IRR.
  • Total AUM rose about 14 percent in the quarter to $282 billion, a 57 percent increase from the same point last year.

Essentials

Banking on secondaries
Two pioneers of Japan’s (relatively small) secondaries market think they’ve spotted an opportunity among the country’s regional banks. This morning, affiliate title Secondaries Investor reported that LP gatekeeper Alternative Investment Capital and secondaries firm WM Partners – both led by veterans of the strategy – are raising a fund to acquire fund stakes primarily from banks and pensions that have piled into the asset class in recent years and are now seeking liquidity. You can find the article on Private Equity International here.

Though still comparatively new to alternatives, Japan’s regional banks – which as of 2019 represented about ¥329 trillion ($2.9 trillion; €2.5 trillion) of assets – have become an important source of capital for domestic GPs, as we reported back in 2019. A Bank of Japan report showed that alternatives and investment trusts accounted for more than 4 percent of regional bank assets in 2018, up from around 2.5 percent five years prior. A growing opportunity, then, for secondaries buyers able to snap up smaller stakes.

Safety in numbers?
One panellist at affiliate title Private Debt Investor‘s recent Debt Week had a contrarian view of GPs’ embrace of a small number of highly favoured sectors such as technology, healthcare and business services. Deals in sectors such as these, he said, were typified by high levels of leverage that made them a “relative value risk” that his firm was unwilling to take.

He pointed out that leverage in these hot sectors had crept up to between 6.5x and 8x, with fund managers taking comfort from large equity cushions, contractual cashflows and high cash generation. But he pointed out that cashflows would need to be very strong to provide effective deleveraging. GPs were making the case to LPs that they were doing the sensible thing by investing in covid-resistant businesses, but are such deals really as safe as they seem? Let us know your thoughts.


Today’s letter was prepared by Alex Lynn and Andy Thomson.