What is the current state of the secondaries market?
After a record 2017, the market is on pace for another record year in 2018 anchored by significant volumes in the first half of this year across both limited partner- and general partner-led transactions.
On the LP front, we saw numerous $1 billion-plus multi-asset portfolio sales by new and repeat sellers. Many LPs are concentrating more of their sales on their real asset, venture, credit and fund of fund exposures given more buyside engagement and record pricing levels.
On the GP front, we are seeing increasingly complex and innovative solutions amidst a forward-thinking mind shift around this market segment. No longer is a GP-led secondaries transaction viewed as a sign of distress, rather, these transactions have firmly entered the toolkit of the sophisticated and savvy manager looking to accelerate distributions to LPs, manage risk within their portfolios and proactively replace legacy LPs with new strategic partners.
Where do you see the market going?
We are predicting significant growth in the GP-led transaction market in the coming years. Recently completed transactions by successful large-cap fund managers are paving the way for other GPs to consider similar deals. LPs are becoming more receptive to these transactions given significant improvements in process transparency, symmetry of information between buyers and existing LPs, and more standardised documentation and timelines.
In some recent transactions, we have also seen individual LPs hiring their own financial advisors or leveraging consultants to assist with the evaluation of the liquidity options being offered. We are also seeing more buyers participating in these transactions as lead and syndicate investors as well as several groups raising dedicated funds or sleeves for these opportunities.
The GP financing market continues to innovate and evolve beyond the sale of minority stakes. We have recently seen the use of structured products, the advent of joint venture structures or more unique waterfalls to address GP succession issues as well as preferred equity solutions to deal with the ever growing and more complex GP level balance sheets. We have seen more LP interest and many new entrants in this part of the market as a result of these innovations.
With most of the larger secondaries funds in the market raising new and larger funds, we remain bullish on overall pricing and volumes in the secondaries market for the coming years.
What should GPs be thinking about?
GPs should think about secondaries as both a means of pro-active fund management and as a potential strategic alternative to traditional M&A. From a fund management perspective, secondaries can be structured to solve for duration, LP liquidity, follow-on capital needs, alignment/realignment of GP economics, portfolio balancing and a myriad of other factors. In addition, as an alternative to traditional M&A (eg, selling a portfolio company), a secondary can be deployed to set a market price as well as to create competitive tension in an M&A process. To this end, dual-track M&A/secondary processes offer an innovative approach that works to provide maximum optionality to both the GP and the underlying investors.
We believe that secondary alternatives should be on the radar of all GPs. While 2008 and earlier vintage funds are fertile grounds for secondaries, the flexibility of the product enables bespoke solutions to be structured for funds, subsets of funds or individual investments of any vintage. Importantly, the fast-paced growth and evolution of the secondaries market have expanded the solution set and the art of the possible so now is a particularly opportune time to get up to speed and/or consider a secondary.
What should LPs be thinking about?
The current market environment is one of choice, where LPs looking for liquidity are not constrained by a diversified portfolio sale to a limited set of dedicated secondaries buyers as the only option. LPs need to think about their non-core portfolio through multiple transaction lenses and potentially segment their sale strategy across multiple alternatives, ideally matching risk and return on a “go forward” basis and identifying the natural buyer(s). Given the meaningful expansion of the traditional and non-traditional buyer universe and the expansion of third party capital available to finance transactions, evaluating the most appropriate counterparty(ies) to engage with is an increasingly more complex decision.
For instance, tail-end portfolios may warrant a preferred equity solution to advance 50-70 percent liquidity at NAV and retaining the residual equity in lieu of a discounted sale. Additionally, securitisations provide a capital efficient mechanism to raise capital against an existing portfolio and potentially secure regulatory capital benefits. This is having a significant impact on the way many LPs manage their alternative exposures.
What transactions are you watching and why are they important?
On the GP-led front, we have seen several successful single company special purpose vehicles transactions completed by marquee firms over the last 18 months. These transactions provide GPs and rolling LPs the opportunity to continue to own successful investments well beyond the normal 10-year term of a PE fund, while creating an efficient liquidity option to selling LPs that prefer to monetise the investment. Most GPs have a successful investment that they would like to own longer, so we see a broad application of this secondary technology by GPs with funds of different sizes and across various strategies (control buyout, club deals, and even VC investments that have grown into growth equity opportunities) and industry segments (eg, real assets and infrastructure).
We are also watching the use of ‘partial’ fund recaps or strip sales to manage risk within a fund or across several funds by isolating specific assets, or geographic or industry concentrations. While a ‘partial’ liquidity option may introduce complexity to the analysis for existing LPs as they decide on whether to sell or ‘roll’, we have seen these transactions generate better pricing and accelerate liquidity for ‘harder to sell’ assets or address idiosyncratic risks within a fund.
With respect to debt, with several transactions already completed and a slate of market leading transactions on the horizon for the second half, 2018 is poised to be viewed as the year that CFOs (collateralised fund obligations), or securitisations, as they are otherwise known, became mainstream. The amount of capital raised, the diversity of the assets that support these transactions and the breadth of issuers has peaked interest from both LPs and GPs. Having the opportunity to maintain manager relationships, retain portfolio upside and improve capital efficiency are attractive benefits to many LPs and several GPs see the structure as a tool to facilitate accelerated DPI and raise additional capital.
We think that this is an exciting time to be in the secondaries market for GPs and LPs alike. Moreover, from an advisory perspective, we are busy challenging ourselves to further expand the opportunity set presented by the secondary market and are focused on creating bespoke solutions for our clients.
This article was sponsored by PJT Partners – Park Hill and first appeared in the September issue of Private Equity International.