The Minneapolis-headquartered firm targets impact, environmental social governance and healthcare funds through portfolio acquisitions and end-of-life restructurings. Chief executive Scott Barrington speaks to Secondaries Investor.
Fund V raised considerably more than its predecessor. What is behind this dramatic increase in investor appetite?
The returns are very strong from our first two funds. By the time we started fundraising for this latest fund, we had already demonstrated our ability to source, invest and successfully exit secondary impact investments. We had to prove ourselves a bit through the first two funds.
Our first fund ($25 million) created this marketplace and was viewed by investors as a test case. Our second fund ($63 million) was raised within a very short window, about six months, and was largely earmarked for a large portfolio that we were arranging to buy from a pension plan.
With respect to that second fund, several consulting and wealth management firms suggested that, had we given them more time, they would have been able to bring us significantly more investors. We listened and allowed for a full year of fundraising for this fund.
What were the questions that kept coming up from investors?
Dealflow and discounts. Most investors want to understand how big the marketplace for impact secondaries is and how we are accessing it. We are buying from two pools: a pre-recession pool that at its peak was $28 billion in size and now is around $4 billion and a post-recession pool that is easily $90 billion and growing rapidly. Once they understood the size of the marketplace and our position at the heart of it, they understood that we could selectively put a $220 million fund to work.
Our pipeline has grown significantly over the years, primarily through our sourcing efforts but also by word of mouth. The marketplace knows if there is an impact, ESG or healthcare fund, they should be showing it to us. We have $200 million of opportunities under review – more than the remaining dry powder in the fund.
How big a discount do you tend to buy at?
We often buy LP interests at 30 percent to 40 percent discounts to net asset value. That is a significant difference from the 5 percent to 15 percent you typically see in the traditional secondary market, which now has billions of dollars sloshing around in it. The impact secondaries market is a nascent, inefficient market.
That said, our best and quickest turnaround on a secondaries investment was acquired at only an 8 percent discount. Investors clearly notice and ask about these big discount numbers – we all like the idea of buying a buck for 60 cents – but the reality is we are underwriting to the same return for every investment and then back into what we are willing to pay. The discount only becomes apparent at the end of our process.
How do you expect fund construction to play out in terms of strategy, deal type and vintage?
We are building a diversified portfolio that we expect will span energy, food, water, transportation, advanced materials, the built environment, sustainable consumer goods, and healthy living and ageing. We are buying buyout, growth equity and venture funds, typically in their fifth to 12th year. We also are doing some restructurings of funds that are approaching the end of their term. We are unlikely to buy infrastructure or real assets funds because the original investor usually is unwilling to sell to us at a price that would allow us to earn our expected double-digit return.
Can you paint a picture of a typical seller? Do their motivations tend to differ in this sub-sector compared with the broader secondaries market?
We buy from college endowments, pension plans, foundations, family offices, banks, insurance companies and sovereign wealth funds. Typically, the seller has had a change internally, such as naming a new chief investment officer, a shift in portfolio allocation or made a decision to reduce the overall number of managers in the portfolio. Motivations are often the same as for the broader secondaries market.
We view our role as providing liquidity to impact investors as a means to enable the overall impact market to grow. We are helping more institutional capital flow into impact investments because they now have a means to change their mind, removing some of the unknowns that can keep new investors from jumping into the marketplace.
Scott Barrington has been managing director and CEO of North Sky since its founding in 2000. The firm was the private equity unit of investment bank Piper Jaffray, before spinning out in 2010.