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Opportunities knock for secondaries – forum

Panelists at PEI's CFOs & COOs Forum, held over the summer, spoke of how the standard GP structure is straining under the weight of value yet to be realised.

Funds are, on average, getting older than the traditional 10-year private equity structure – a boon for the rapidly growing secondaries market, said panelists at PEI’s CFOs & COOs Forum 2021, held over the summer.

PE funds with 2004-08 vintages on average retain unrealised value of 9.2 percent. This leaves $175 billion-$180 billion of potential dealflow for the secondaries market, according to one panelist, which is nearly three times the entire volume in 2020. Extend that to the entire universe of active PE funds and there is nearly $3 trillion of unrealised value, the panelist added. In that light, the projection for a $1 trillion secondaries market begins to sound bearish.

Reflecting the rise of GP-led transactions targeting trophy assets, unrealised gains were concentrated around the best performers. The top 5 percent of funds with 2007 and 2008 vintages still held 40 percent of unrealised assets, according to the panelist. This phenomenon is even more pronounced in venture capital.

Assets are being held over a longer period. Analysing more than 15,000 realised transactions, the average hold increased from 3.8 years in 2010 to 5.5 years in 2019, according to the panelist.

The heft of aging assets will further fuel the growing secondaries market, and the trend is producing other strategies to keep funds running. Among them are continuation funds, of which many types have come into being, including traditional GP-stake sales. These, of course, can present their own challenges, though at times a GP can entice a dominant LP in an existing fund to buy up the other LP interests, then roll that into a new fund.

The key factor in doing these deals is the GP’s credibility. Conflicts of interest are rife in GP-led transactions and other kinds of continuation funds. Panelists agreed disclosure is key. Tax issues with these transactions can be tricky, and negotiating them can be time consuming. One panelist spoke of a 750-page document for one transaction that took months to produce.

The average fund life has been getting longer, another panelist said, reflecting longer asset holds and harvest periods. Still, the legal framework of partnership agreements has not changed. GP-led secondaries, continuation vehicles and other secondary technologies are putting downward pressure on that duration. “Ten-plus-two just doesn’t work as well nowadays as it did, historically in part because managers are more inclined to hold assets for longer periods,” said a panelist, “particularly the best-performing assets.”

“The flexibility and creativity around these deals has increased enormously, because the large stock of assets to which this applies gets bigger every year. The 10-plus-two construct is creaking at the seams.”