Bego: smaller sellers are poorly served

The majority of the secondaries market is dominated by large players with funds larger than $1 billion. Secondaries Investor spoke to Kline Hill Partners’ Mike Bego about how his firm plans to cater to the smaller end of the market.

What is Kline Hill’s strategy in the secondaries market?

The market is dominated by the large secondaries funds. Well over 95 percent of the capital is deployed by funds that are bigger than $1 billion. Most of the dollars and headlines are about quite large transactions – $50 million or up. We feel sellers looking to sell the smaller interests are often poorly served or have challenges to get transactions completed in comparison with sellers of chunkier positions.

A lot of the professional, well-run firms have become much larger, and our intention as a firm is to make a dedicated, professional institutional platform to work with the smaller sellers. This smaller deal niche is highly fragmented but, at $4 billion per year, quite large. The smaller sellers are looking for professional counterparties for price discovery and execution but it can be hard for them to find a good buyer. There are other small firms, but some have limited asset focuses (for example, only venture or buyout), and some small firms still primarily invest in large transaction, and at times there are larger firms who look at small deals but not with the same enthusiasm as they do for bigger deals.

Furthermore, intermediaries, who have really helped professionalise and grow the secondaries market, often don’t want to work with smaller transactions as they don’t justify significant efforts.

By small, we don’t necessarily mean by total deal dollar size, we mean small cheque size per individual fund or fragmented larger transactions. It could be a €30 million deal with 20 plus funds. That would be one where it might be more challenging to get many funds interested. While we often purchase from individuals, a majority of our transactions are with large institutional investors who just have small pockets of assets.

Kline Hill, and a few others, are branching out with niche strategies. Does this mean the secondaries market has hit a peak?

People had niche strategies early on in the secondaries industry, so it doesn’t necessarily imply the market is mature. However, if you look at annual volumes, from 2014 to 2015 the volume went from $37 billion to $42 billion, and it sunk a little bit last year. If you talk to intermediaries and larger firms, this year got off to a slower start than last year. Our projection for this year so far is $35 billion to $40 billion.

With total private equity assets of around $2.3 trillion, the current turnover represents only about 1.8 percent a year. It’s hard to predict where long-term annual volumes could go, but at a relatively small volume currently compared to many other asset classes, there appears to be the possibility for substantial increases.

If the market keeps growing, this could support additional players. The question is, if the market contracts a bit, will we see consolidation among firms.

What are some of the main drivers you are seeing behind sales?

There are three different areas that that could get resolved in terms of liquidity.

One is limited partners selling interests in older funds to recommit their capital or clean up their balance sheets. The second is, obviously restructurings have been a growing trend for the GPs who want their funds to continue and maybe source fresh capital and new limited partners. Thirdly, funds, and especially older funds, tend to work hard to find good exits for their portfolio.

What new types of deals are you seeing in the space you operate?

Fund terminations are an increasing trend and fund of funds transactions have been on the rise in recent years. [My view is buying stakes in funds of funds] should increasingly be completed by savvy limited partners rather than secondaries funds. The diligence and pricing process for fund of funds is naturally more limited. While they have been a strong performing category for some secondary funds, LPs with a lower cost of capital could increasingly step into this space in the coming years.