Schroders Capital held a final close on $410 million for its latest private equity secondaries fund, Schroders Capital Private Equity Secondaries IV, earlier this month. The vehicle is almost 52 percent larger than its predecessor, which closed in 2018 on $270.9 million.
Speaking with Secondaries Investor, Christiaan van der Kam, head of secondaries private equity at the firm, details where opportunities are to be found in the lower mid-market.
Will Fund IV be doing more transactions than its predecessor, or larger sized deals?
Our secondaries strategy has remained consistent the last few years – committing to investing in lower mid-market businesses with enterprise values below $500 million. We can write sizeable tickets across the platform (up to $80-100 million per company), to shape the transactions and invest as a meaningful counterparty with our sponsors.
We typically invest in 10 to 15 GP-led transactions annually, with an average ticket size between $30 million-$60 million. Diversification is a key consideration for our secondaries [strategy], through which we target 30 to 40 portfolio companies, with no single exposure representing more than 5 percent of the fund.
How will the fund approach different geographies?
We target Europe and North America to be 40-45 percent each, with the remaining 10-20 percent in Asia. These are broad targets and can differ by year depending on where we see the most attractive opportunities. For example, this year we have seen many interesting GP-leds in Europe and have in turn deployed the majority of our capital in such investments.
We also believe there is meaningful potential in Asia, particularly India. [We] have recently hired a senior investment professional in Singapore to lead our secondaries efforts in the region. The US, being the largest private equity market globally, will always generate opportunities for GP-led deployment.
Fund IV closed above its target. What was the feedback from LPs who backed the vehicle?
Investors were excited about investing in a GP-led secondaries fund focused on the lower mid-market. GP-leds are still a fairly new market, with few realised returns. However, we have a deep track record of GP-led investments since 2009, which have generated positive performance and highlight the return potential of the asset class. We also have demonstrated for our investors that lower mid-market GP-leds offer attractive value creation potential and alignment of interest versus larger GP-leds, which involve more mature assets and can be transactional in nature.
As you say, Schroders has been particularly active in the GP-led secondaries market. Why has this area been so attractive compared with the LP-led market for the firm?
GP-leds provide favourable risk-adjusted returns versus LP-led secondaries transactions. The assets are generally higher quality, the market is more inefficient and there is increased value creation across a given opportunity. The investor community broadly appreciates the attractiveness of GP-leds, but the most important factor when making an investment is ensuring we can properly diligence and correctly price an asset.
The challenge of LP-leds is that investors are restricted in their ability to conduct deep due diligence. The result is creating a highly diversified portfolio, but ultimately [it] becomes a levered beta play on large-cap private equity. A statistically diversified portfolio of GP-led investments should inherently generate stronger returns.
What are the key trends colouring lower mid-market buyout and growth equity segments in secondaries?
High inflation and interest rates continue to affect global markets. Lower mid-market businesses have been somewhat protected from the interest rate volatility, given their lower absolute leverage levels. However, sensitising cashflows and operating performance to a higher interest rate environment is a key part of our diligence. We have seen [that] higher interest rates have slowed financing for M&A, so the inorganic growth opportunities have needed additional time to materialise. We believe these trends will continue to shape the private equity landscape for the foreseeable future.
Pricing and valuation in the current environment are of utmost importance. Companies should not be priced as they were at the peak of the market. An exciting development is that we now have a few years of post-covid visibility in the underlying company performance. We are starting to see which companies benefited from covid and which ones did not. This increased visibility is a key component of projecting future growth potential.
What are you looking for in both a GP-led transaction and an LP-led transaction?
In GP-leds, we target asset quality, alignment of interest (across the GP and management), strong management capabilities and tangible value creation opportunities. In LP-leds, we are selective and target funds we know well through our primary and co-investment relationships, but specifically those where the buyer universe is restricted by the sponsor. We do not compete in large, broad auctions.