What is the appeal of secondaries for investors?
In addition to offering attractive risk-adjusted returns for investors, classic limited partnership (LP) secondaries are an attractive way to deploy capital into private markets, owing to:
- Diversification: immediate access to diversified PE exposure across strategies, vintages, geographies, sectors and fund managers.
- Visibility on portfolio quality: ability to assess the quality and valuations of the underlying assets, as well as how future value might be created and exits achieved from the portfolios.
- Accelerated value creation: driven by the ability to acquire interests at a discount to net asset value (NAV), combined with the embedded value and short-term valuation growth potential.
- Reduced investment horizon: ability to deploy money and receive cash returns over a shorter period than is typically possible via primary investing. General partner (GP)-led secondaries offer many of the same attractions but tend to be more concentrated. They offer a different profile of return that is more weighted towards money multiples rather than internal rates of return.
The drivers of recent strong growth for GP-led secondaries
GP-led deals have emerged over the past decade and accelerated in the last five years. So much so that the GP-led segment made up around half of the market in 2021. Initially focused around restructuring poorer-performing funds and managers, GP-led deals have been entirely embraced by some of the best-quality managers as a way to offer more consistent liquidity to their investors and to hold favoured assets for longer.
In terms of recent deal activity, the GP-led space has proved to be surprisingly resilient and has continued growing despite public market volatility. This is because GP-led deals tend to comprise a limited number of high-quality assets. Buyers are able to gain sufficient comfort and conviction through detailed and up-to-date diligence on financial performance and ongoing value creation.
GP-led deals have emerged over the past decade and accelerated in the last five years
Will the GP-led momentum be sustained?
In the short term, there will be some impact from the recent market slowdown as buyers and GPs readjust to the new circumstances. We have already seen that some GP-led deals are taking longer to complete, pricing has become less frothy, and GPs’ demands in terms of their economics have moderated. However, with exit markets becoming more constrained, GP-led deals could actually become an even more attractive means for GPs to offer liquidity to investors when the usual exit routes (e.g. an initial public offering or secondary buyout) have tightened.
From a broader perspective, the GP-led phenomenon has only just begun and will continue gathering momentum in the future. Some GPs have been enthusiastic early adopters and have already completed several continuation funds. Some see it as a key promise to their investors to offer liquidity after their funds hit the 10-year mark. Others have been slower to react or have preferred to watch how things develop. We are seeing the technology developed by the larger GPs now trickling down into the mid- and lower-mid market.
How has the market for classic LP portfolio secondaries developed relative to the GP-led space?
Diversified LP portfolios with exposures across assets and sectors have been affected by recent market downturns. It has been more difficult for buyers to evaluate as the latest portfolio valuation and trading information became stale quite quickly. In the absence of a clear picture, buyers tend to become cautious and to build contingencies into their pricing analysis, which results in them bidding at material discounts to NAV. Sellers have tended to wait rather than accept taking a big loss on a sale.
This is exactly what we saw in the second quarter of 2020, following the onset of Covid, and also in the second quarter of 2022, as tech valuations and stock market uncertainty hit buyers’ confidence. There are some signs that LP secondary volumes are starting to pick up again, albeit with buyers still being relatively cautious and selective. Sellers that have been waiting to launch a process and investors facing over-allocation pressure or liquidity issues are expected to come to market from the fourth quarter of 2022.
Identifying value in the competitive secondary market
Our focus tends to be on less well-addressed pockets of the secondary market. We tend to avoid those areas that are targeted by the largest buyers. We prefer areas where our platform helps provide an angle for us to win, either through our GP relationships or insights into underlying assets. Our targeted niches tend to have more opaque information, structural complexity, or GPs that restrict who can buy into their funds. These factors reduce the level of buyer competition relative to the mainstream market, but allow us to capture attractive relative value while not compromising on asset quality.
Final thoughts…
This year’s market dislocation has undoubtedly created challenges in the secondary market, with periods when LP portfolio trades were effectively halted and GP-led deals adjusted to the new macroeconomic environment. However, it’s encouraging to see signs that seller pricing expectations, especially on LP secondaries, are now becoming more realistic. In addition, given that other exit options are less viable given the market backdrop, the liquidity benefits of GP-led secondaries have become even more attractive. Despite rapid growth in recent years, the secondary market is gaining momentum and we believe there's more growth to come.
What is the appeal of secondaries for investors?
In addition to offering attractive risk-adjusted returns for investors, classic limited partnership (LP) secondaries are an attractive way to deploy capital into private markets, owing to:
- Diversification: immediate access to diversified PE exposure across strategies, vintages, geographies, sectors and fund managers.
- Visibility on portfolio quality: ability to assess the quality and valuations of the underlying assets, as well as how future value might be created and exits achieved from the portfolios.
- Accelerated value creation: driven by the ability to acquire interests at a discount to net asset value (NAV), combined with the embedded value and short-term valuation growth potential.
- Reduced investment horizon: ability to deploy money and receive cash returns over a shorter period than is typically possible via primary investing. General partner (GP)-led secondaries offer many of the same attractions but tend to be more concentrated. They offer a different profile of return that is more weighted towards money multiples rather than internal rates of return.
The drivers of recent strong growth for GP-led secondaries
GP-led deals have emerged over the past decade and accelerated in the last five years. So much so that the GP-led segment made up around half of the market in 2021. Initially focused around restructuring poorer-performing funds and managers, GP-led deals have been entirely embraced by some of the best-quality managers as a way to offer more consistent liquidity to their investors and to hold favoured assets for longer.
In terms of recent deal activity, the GP-led space has proved to be surprisingly resilient and has continued growing despite public market volatility. This is because GP-led deals tend to comprise a limited number of high-quality assets. Buyers are able to gain sufficient comfort and conviction through detailed and up-to-date diligence on financial performance and ongoing value creation.
GP-led deals have emerged over the past decade and accelerated in the last five years
Will the GP-led momentum be sustained?
In the short term, there will be some impact from the recent market slowdown as buyers and GPs readjust to the new circumstances. We have already seen that some GP-led deals are taking longer to complete, pricing has become less frothy, and GPs’ demands in terms of their economics have moderated. However, with exit markets becoming more constrained, GP-led deals could actually become an even more attractive means for GPs to offer liquidity to investors when the usual exit routes (e.g. an initial public offering or secondary buyout) have tightened.
From a broader perspective, the GP-led phenomenon has only just begun and will continue gathering momentum in the future. Some GPs have been enthusiastic early adopters and have already completed several continuation funds. Some see it as a key promise to their investors to offer liquidity after their funds hit the 10-year mark. Others have been slower to react or have preferred to watch how things develop. We are seeing the technology developed by the larger GPs now trickling down into the mid- and lower-mid market.
How has the market for classic LP portfolio secondaries developed relative to the GP-led space?
Diversified LP portfolios with exposures across assets and sectors have been affected by recent market downturns. It has been more difficult for buyers to evaluate as the latest portfolio valuation and trading information became stale quite quickly. In the absence of a clear picture, buyers tend to become cautious and to build contingencies into their pricing analysis, which results in them bidding at material discounts to NAV. Sellers have tended to wait rather than accept taking a big loss on a sale.
This is exactly what we saw in the second quarter of 2020, following the onset of Covid, and also in the second quarter of 2022, as tech valuations and stock market uncertainty hit buyers’ confidence. There are some signs that LP secondary volumes are starting to pick up again, albeit with buyers still being relatively cautious and selective. Sellers that have been waiting to launch a process and investors facing over-allocation pressure or liquidity issues are expected to come to market from the fourth quarter of 2022.
Identifying value in the competitive secondary market
Our focus tends to be on less well-addressed pockets of the secondary market. We tend to avoid those areas that are targeted by the largest buyers. We prefer areas where our platform helps provide an angle for us to win, either through our GP relationships or insights into underlying assets. Our targeted niches tend to have more opaque information, structural complexity, or GPs that restrict who can buy into their funds. These factors reduce the level of buyer competition relative to the mainstream market, but allow us to capture attractive relative value while not compromising on asset quality.
Final thoughts…
This year’s market dislocation has undoubtedly created challenges in the secondary market, with periods when LP portfolio trades were effectively halted and GP-led deals adjusted to the new macroeconomic environment. However, it’s encouraging to see signs that seller pricing expectations, especially on LP secondaries, are now becoming more realistic. In addition, given that other exit options are less viable given the market backdrop, the liquidity benefits of GP-led secondaries have become even more attractive. Despite rapid growth in recent years, the secondary market is gaining momentum and we believe there's more growth to come.