Arcano Secondary Fund XIV, which targets smaller, less competitive transactions at attractive discounts across LP stakes and GP-led transactions in the US and European mid-market buyout space, had a €300 million initial target.
Secondaries Investor caught up with Ricardo Miró-Quesada, partner and head of private equity at the Madrid-headquartered firm, on the back of the fund’s close to discuss how the firm will deploy the capital and which areas it sees opportunities in.
Were there any new investors to ASF XIV? What do you think attracted them to secondaries as well as your strategy?
We were excited to bring on several new investors in ASF XIV, strengthening our institutional LP relationships. We found that investors continue to show a keen interest in secondaries given the unique properties of the asset class, namely heightened levels of diversification complemented by consistent returns across an extended period of time. In addition, investors are attracted to private equity generally given the outperformance relative to other strategies and find secondaries as a way to access the asset class on a shorter duration basis.
As it relates to Arcano specifically, our investors appreciate our fund size as a means to gain meaningful access to all segments of the private equity market, particularly in the lower and middle markets, where it’s tougher for some of our peers to build meaningful positions given their larger fund sizes. We also tend to be conservative as it relates to transaction and fund level leverage, which has not been at the expense of returns necessarily. Finally, we find consistency is key, and although our strategy has evolved over time, we have always focused on backing top notch managers in the US and Europe, who are investing in high quality and recession resistant businesses via buyout transactions.
All of these were confirmed by an independent third party when in July, 2022 we made it to the top 10 globally in the HEC Paris-Dow Jones ranking of private equity secondary funds. This list ranks the top PE secondary fund managers globally, out of more than 200, in terms of cumulative performance and consistency of funds raised between 2008 and 2017.
Arcano invests in defensive sectors with resilient business models. Are there any areas specifically the team currently finds particularly attractive?
A meaningful part of investing in defensive businesses is constantly evaluating various sectors, trends, business models and financial profiles, which may evolve and change over time. Sector aside, we focus on businesses with durable customer/client relationships and sticky revenue profiles, complemented by strong margins. Today, we find such characteristics in a variety of speciality and niche healthcare, business & financial services, and software & technology companies. We are also attracted to those businesses which drive positive impact, including key themes such as energy transition and behavioural health where the duality of positive impact and strong investment outcomes can thrive.
Walk us through what makes a potential GP-led transaction a strong investment opportunity for Arcano. How are you sourcing these transactions where a discount can be had?
We are seeing a record amount of dealflow on the GP-led side of the market, an area where we have been active for some time now. Given this heightened deal flow, it’s more important than ever to work with GPs with longstanding track records and strong reputations, and ideally those where our relationships predate the contemplated secondary transaction. Alignment is key. We tend to shy away from deals where the GP’s intentions aren’t clear, or where they are utilising the secondary market as a tool to provide liquidity on potentially sub-par assets. As it relates to discounts, a lesser understood dynamic is that they come in many shapes and sizes. For example, the reference date pricing may be close to par, but we focus on the post reference date activity such as EBITDA growth or accretive M&A, that may imply better pricing at entry by the time the transaction is closed. In today’s market, we are benefiting from our strong network with GPs, resulting in a robust pipeline of deals, many of which are being priced at discounts to reference date NAV given some of the current market dislocation.
Likewise, how do you source your LP-led transactions where an attractive discount can be negotiated?
Discounts are no doubt widening as market dislocation ensues, and LPs search for liquidity to rebalance their portfolios. We like to be creative and find ways to find mutually beneficial solutions for all parties. A good example are large fund books where there may be certain managers with highly restrictive transfer clauses, only allowing existing investors to transfer into the funds, for example. Given our strong network as primary investors in funds, we are constantly bidding on carve outs of larger portfolios, where our solution as one of the few authorised transferees is accretive to the overall package for the sellers. We also work directly with GPs, particularly on the lower end of the market, to find solutions for their smaller LPs where there may be less buyer appetite.
Beyond your four dedicated secondaries raises, how much capacity does Arcano have to invest across secondaries including other vehicles the firm manages?
We have several additional pockets of capacity to invest across secondaries – both from our diversified multi-strategy funds-of-funds as well as our growing number of separately managed accounts.
What is Arcano’s predictions for secondaries activity in your market in 2023?
I think we are going to see a good amount of activity in 2023. Several GP-led deals which were in the market in 2022 are now slated to close in early 2023. I also believe that GPs will continue to lean into the secondary market as an alternative tool to generate liquidity, while the IPO and M&A markets operate at potentially depressed levels. On the LP side, a lot will depend on the behaviour of the public markets and the duration of this economic uncertainty, but we are seeing several large fund books as well as smaller transactions hit the market early here in 2023, implying an active year in the LP segment as well.
Ricardo Miró-Quesada is a partner and head of private equity for Arcano Asset Management. He has been with the firm since 2009 and was previously at Citigroup.