Growing pains as GP-leds move towards standardisation

There are two recurring topics that continue to be ripe for discussion in the GP-led secondaries market: the returns that could be attained when trophy assets are rolled into new funds for further development with a known GP; and the alignment needed to make that happen.

This week, two reports reflect on where the market is on these topics. Research from Upwelling Capital Group has found LPs that systematically avoid rolling over their exposure to continuation funds are incurring a tangible opportunity cost of around 8 percent per vintage year. Compounded, the cumulative opportunity over a 10-year period “could be in excess of 15 percent of total cash-on-cash returns”, the report notes.

On the topic of alignment, a survey carried out by Mizuho Company-owned placement agent Capstone Partners shows there’s a significant gap between GPs’ and investors’ respective priorities – and their concerns – when it comes to GP-led transactions.

No carry rollover is seen as the biggest red flag in GP-led transactions for investors, with the majority saying reinvestment of carry was the number one priority with the launch of a GP-led process. For GPs, just 7 percent of respondents cited a lack of carry rollover as a red flag for LPs. For GPs, their main challenge was dealing with conflicts of interest in these transactions, while LPs provided more of a sweeping list of the challenges they believe GPs face.

Such reports reflect the ongoing battle to perfect and streamline these transactions.

Some LPs feel burdened with the growing number of continuation fund transactions coming across their desks. According to Capstone’s survey, half of LPs reviewed more than 10 such transactions in the first half of this year with market estimates suggesting the majority are selling out. Across the whole of 2021, 67 percent of LPs reviewed fewer than 10 transactions, the report said.

Worryingly for GPs, over one-third of LPs surveyed by Capstone indicated that they expect GP-led transactions to have a negative impact on future fundraising. No GPs indicated this.

Such information needs context. GP-led secondaries have undergone an image change in recent years, evolving from an association zombie funds to become tool to retain and further grow top-performing assets.

On the GP side, there are certainly lessons to be learned from these deals. “There will be some bad players in deals, and people will recognise that structure can cure a lot of that,” Steve Standbridge, managing partner and president of Capstone, told Secondaries Investor. Careful structuring is expected to standardise stronger alignment between LPs and GPs

Ongoing outperformance, as Upwelling’s research points to, could lead LPs to either staff up their teams or shift resources, allowing them to dedicate more time to GP-led opportunities.

The findings of these reports look disconcerting at first read. They point, however, to the natural evolution of a maturing market.