There are tailwinds for secondaries buyers across both the LP-led and GP-led sides of the market, Jeff Keay, managing director and chair of HarbourVest Partners’ secondaries investment committee, tells affiliate publication Private Equity International.
Most institutional private equity portfolios held by LPs are cashflow negative at present – a different world from the last cycle, where most mature private equity portfolios were “essentially self-funding – cashflow positive”, Keay explains.
“I don’t think that most institutional investor forecasts or cashflow models anticipated a world where they’re not self-funding… That’s having real implications in terms of pacing, in terms of how [LPs are] sizing commitments to managers that are coming back to market.”
This environment creates pressure for institutional investors to sell fund commitments directly on the secondaries market. It will also result in a higher uptake of LPs accepting the liquidity option made available by GP-led deals, he adds.
“Most institutional investor forecasts or cashflow models [didn’t anticipate] a world where they’re not self-funding”
Jeffrey Keay, HarbourVest
The secondaries market is constrained by the amount of dry powder it has to commit to transactions. A sophisticated approach to the market could mean a better chance of catching the eyes of secondaries buyers that are overrun by opportunities. As such, it’s important that LPs are thoughtful about which assets they want to sell, Keay says.
Selling is going to come at a discount, given the premium on liquidity and the current risk environment. However, investors are inevitably going to see stronger pricing for more cashflow-positive, stable, growing assets, rather than for assets that have meaningful financial risk.
“It’s important for sellers to keep in mind what risk factors buyers may be sensitive to in order to be able to transact at prices that are within a range of acceptability, in terms of the discounts that they’re prepared to accept,” Keay notes.
When it comes to GP-led transactions, the market is even more undercapitalised. There is greater execution risk for those managers considering a continuation fund of $1.5 billion-$2 billion in size, given that a single buyer is unlikely to have capacity to underwrite a transaction of that size in its entirety.
“When a GP is looking to do a GP-led deal of that scale, one of the most critical factors for them – in addition to someone that’s experienced and has the expertise to lead a deal – is you need scale capital,” says Keay. “You need an anchor investor who can provide that type of certainty and de-risking of that financing risk that exists.”
Potential for volatility
The topic of interest rates is still front of mind for those in private markets. Exactly what impact sustained higher interest rates will ultimately have on the overall economic environment still remains to be seen, Keay says.
There are two extreme views, he explains: one is that it’s going to catch up and result in some volatility in 2024. The other is that the Fed and other central banks have pulled off a balancing act and we will see a soft landing with strong public market performance moving through this year. As we wait to see which prediction turns out to be correct, buyers and sellers will be translating risk assessment into their own return expectations and capital allocation plans.