Sister publication Private Equity International recently sat down with some of the secondaries market’s leading participants for a roundtable discussion in New York. In this first excerpt from the article, executives from Greenhill Cogent, Ardian, HarbourVest and AlpInvest Partners discuss how to produce attractive returns in LP fund stake sales.
Growth in the secondaries market has traditionally been driven by limited partners selling portfolios of fund interests.
Traditional sales of limited partnership fund interests accounted for about $32 billion last year, or 80 percent of the total secondaries market, according to data from advisory firm Greenhill Cogent.
Industry participants who gathered recently in the New York offices of Debevoise & Plimpton to discuss the secondaries market believe that the LP fund stake business has become efficient in the last couple of years, with advisors typically running auctions and the bidder with the highest price winning.
“That part of the market has been generally expensive,” says Wouter Moerel, a managing director with AlpInvest Partners. “There’s been a flight to quality and people are paying for that.”
“There are lower barriers to entry there,” adds Jeff Keay, a managing director with HarbourVest. “Typically in those transactions, the one factor you’re negotiating is price, and so it’s a more straightforward part of the secondaries business, and the most intermediated.”
There are still ways to produce attractive returns with LP fund interests, but market participants need to have an edge. One way to be able to compete is to use financial engineering, most often in the form of leverage or deferred payments, which allows a buyer to pay in installments. Focusing on very large portfolios and the ability to move fast by having intelligence on funds’ valuations also present clear advantages.
“We sit on more than 500 advisory boards and so have deep access to funds we know we like and know well,” says Keay. “Outside of that universe, if we don’t have an information advantage or an attractive competitive dynamic, the deal is usually not for us.”
Ardian for its part has made a speciality of focusing on very large portfolio sales and has used leverage and its proprietary database of funds to close transactions. Its database of about 1,200 funds is mined every quarter with regular repricing of the underlying assets in each fund, allowing the firm to find undervalued funds and mispriced assets and then purchase those stakes in the market.
As a result of focusing on the upper end of the market, it is operating in a less competitive environment, says Vladimir Colas, a managing director with the firm, and it is also able to move fast on transactions that could contain about 300 funds and 4,000 companies each. “If you’re not already equipped to do that, if you don’t already have all these funds in your database, it’s difficult to do those deals,” he says.
The sale of LP fund stakes becoming such an efficient market has obvious drawbacks, the main one being higher pricing, but it also presents some clear advantages. In recent years, it has allowed funds of funds and secondaries buyers to sell tail-end portfolios as a way to wind down older funds. Secondaries buyers would typically let funds run the course of their life naturally, but with the average fund now taking longer than its originally-agreed terms of 10 years with two extensions to liquidate, selling in the secondaries market can be beneficial for logistical as well as liquidity reasons.
“The market is getting to a point where we are likely to see a steady and constant need – for fund of funds managers generally speaking but for others as well – to sell tail-end portfolios as the amount of NAV in 10-plus year-old funds grows,” says Chris Bonfield, a managing director with Greenhill Cogent.
Small teams at some LPs can easily get overwhelmed with monitoring tail-end funds and investors are often better off selling them on the secondaries market. If they commit to 10 new funds every year, and only two funds liquidate, then it gets to a point where the administrative requirements to monitor the funds, process extension requests, K-1 filings and so on justify a clean-up sale, Bonfield says.
LP fund stakes will continue to represent the bulk of the secondaries market, the roundtable participants agreed.
Stay tuned for the second excerpt of PEI’s secondaries roundtable which will be published on Secondaries Investor later this month.