One area of private equity is flourishing: the secondaries market. Speakers and panellists at SuperInvestor 2019 shared their expertise and thoughts on the future of the market and considered how to mitigate risks while generating innovative and creative financing solutions.
A hot bed of innovation, the secondaries market is enjoying stellar growth and lots of attention.
Once seen as the backwater of the industry, it’s now moved into the mainstream, offering investors ways to customise their involvement in the sector with a constantly evolving array of tools and new mechanics. Secondaries are now widely used to generate liquidity, introduce flexibility and make portfolio adjustments.
That’s helped the market balloon to $74 billion of transaction volume in 2018 from $58 billion in 2017, research from investment bank Greenhill & Co shows. And the expansion is set to continue, according to delegates in Amsterdam.
“Private equity is kind of dull, but secondaries are super interesting,” said John Daghlian, a partner at Akin Gump LLP. “If you want to see things done differently, there are new kinds of deals the whole time, the market is so competitive, and there are always new kinds of innovations.”
Sweta Chattopadhyay, Director at bfinance, joined us for an exclusive interview on the evolution of the secondaries market, how strategies have become more sophisticated, and why you should be investing in the market.
More tools, more mechanics
A plethora of financing and structuring options are now available, including single-asset deals, preferred equity deals and GP-led transactions.
GP-led secondaries are booming, making up around 32% of deal volume in 2018, according to Greenhill. Many of the SuperInvestor delegates said that area of the market was also becoming increasingly sophisticated, which is leading to customized solutions.
Even so, such deals aren’t without risk, they noted, with some hiccups along the way.
“With the GP leads, it’s about right structure, right process and right mindset,” said Yann Robard, the managing partner of Whitehorse Liquidity Partners. “At the end of the day, what you’re doing is providing options, but not obligation, for liquidity.”
Michael Woolhouse, Managing Director, Head of Secondaries at CPPIB, discusses that factors that make the secondaries attractive, the role innovation plays in manager strategies, and what keeps driving the continual growth of the market.
With so much innovation and the creation of different ways to inject liquidity, it’s important not to lose sight of the alignment between all the different parties involved. Everyone must be on the same page, and focused on achieving a similar outcome. This is critical in secondaries as often there’s not as much time for due diligence as there is in a full buyout.
Investing alongside someone who knows the company is a helpful strategy here, while also making sure you understand their motivation for spitting the deal.
As the market comes of age, single-asset deals are growing in popularity, and another panel at the conference discussed the best ways to price and structure these and how investors are becoming more comfortable with them.
It’s not just fees and carry that make these deals attractive, they can help assets sit within a private equity portfolio for a few extra years, or provide a little extra investment when needed.
“It’s important to be clear as to why the GP is doing the deal,” said Matt Jones, a partner at Pantheon. “If they have one of their very best assets that they don’t want to give up, if they’re rolling over and they know the asset well, then you have a good deal.”
Valuing single-asset deals can be challenging, since by their nature there is less diversity and that makes it riskier in some ways. That’s where a focus on the bottom up can come in handy and going to visit the asset before committing, as can putting a cap on your investment as a percentage of the total.
“You want to understand what the motivation is,” said Laura Shen Lefranc, a partner at Headway Capital Partners. “Could they sell the asset today? If so, why aren’t they doing it? If not, why not?”
The flexibility of the secondaries market means there’s no one size fits all solution. Each transaction can be approached in an innovative way, and hopefully, one that works for all parties.
For Patrick Knechtli, head of secondaries at Aberdeen Standard Investments, it’s about working out what each party is seeking, then asking “how can we make it work?” Situations can be winning for all, he said, offering good potential to new investors while also giving those that have been tied up in a very illiquid asset the chance to exit.
“It is about finding the right buyer,” Knechtli said. “These are complex situations, and what’s interesting about it is that you go to the market pretty much knowing who the likely buyers are, it’s a narrow field and that gives the opportunity to craft something together.”
For Charles Tingue, a partner at Landmark Partners, the secondaries market is about tailoring something to meet specific goals. It also comes back to alignment again and making sure all parties have an interest in a positive outcome.
“As the market has got more frothy it’s important to be selective,” he said. “You have to structure the transaction carefully.”
As more GPs grapple with how to harness the power of the secondary market, there’s been an increase in the breadth and scope of structured liquidity solutions. The delegates agreed that this market is constantly evolving as are it’s uses. It can be used to “clean up” different funds, or to create reinvestment opportunities.
“You can craft solutions that are tailored to a specific problem,” said Valérie Handal, managing director at HarbourVest Partners. “It is about listening to the owners of the assets and what they are trying to achieve.”
Offering liquidity in these multiple ways and scaling up transactions is ambitious and one of the side effects is that it can create complex deals with multiple parties involved.
It’s vital to have a good lawyer and one who understands secondaries, since Handal noted that the transactions are less painful when you don’t need to educate the other side. “It’s not the same as an M&A transaction,” she said.
As for where the secondaries market is headed, there’s no holding it back, and the panellists predicted it will exceed $200 billion by 2025.
“There is huge growth left,” said Robard. “We’re innovating, we’re growing, we’re evolving.”