The value, and limits, of primary investing

Investing in primary funds has increasingly brought a strategic edge to secondaries buyers, especially as fund information becomes scarce.

Secondaries buyers with the capacity to make primary investments have always had a certain advantage in the industry. Nowadays, this is truer than ever.

Primary investments can help secondaries firms build valuable relationships with general partners, create leads for secondaries investments and also expedite the due diligence process when faced with a large portfolio of fund stakes they need to analyse in a short timeframe.

“Investing on the primary side is an important part of our business,” said one secondaries fund manager with the ability to invest in primary funds. “We want [GPs] to let us know when someone needs liquidity in one of their funds. We want them to tell us what’s going on in the funds. We want them to agree to transfer to us, although they certainly have no obligation to do any of those things.”

Most secondaries buyers have primary capacity, but it can take different shapes. For traditional funds of funds, primary investing can be a large portion of their business, with dedicated programmes that have been investing for decades. Firms that fall in this category include Ardian, Adams Street Partners and HarbourVest Partners.

Secondaries buyers without dedicated primary funds often allocate a certain percentage of their funds, typically around 10 percent, to invest in primaries, in support of secondaries transactions, such as in stapled transactions, and as standalone investments.
This is the case for Lexington Capital Partners VIII, which closed in 2014 on more than $10 billion, and Landmark Equity Partners XV, which closed at the beginning of 2015 on more than $3 billion. Both funds have made primary fund commitments to BC European Capital X, which launched in January with a €7 billion target and is still in market.

The reason why primary investing for secondaries is more important than ever is twofold.

First, as secondaries transactions have become more commonplace in the last decade, general partners have created lists of pre-approved buyers, typically existing limited partners. “They have an approved list of investors and they would block whomever is not on it,” according to one source.
“We’ve had transactions where the general partner did not consent to transfer to somebody else and directed the seller to us,” concurred the fund manager.

The second reason that primary investing is becoming a more valuable element of the secondaries market is increasingly scant information about what is on sale.

“We see a lot of transactions where the seller comes and says ‘I own interests in these 10 funds, here’s my net asset value and that’s it. Let me know what you’re willing to pay,’” said one secondaries advisor. “Well, if you don’t have the information, you effectively can’t be a buyer.”

While it’s true having primary investing capabilities is a huge advantage for a secondaries buyer, it is not enough in itself. The required skills to be a competitive secondaries buyer also include the ability to do bottom-up analysis of each portfolio company in a fund, a skill that’s more akin to direct investing than primary fund of funds investing.

The growing importance of primary fund capabilities in the context of secondaries investing essentially means higher barriers to entry to the space, particularly at the larger end of the market.

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