Twist in the tail

While tail-end portfolio sales are a growing part of the secondaries market, their heavy reliance on discounts and leverage can come back to sting buyers.

Ardian is currently shopping a tail-end portfolio larger than $1 billion, we revealed on Thursday. Meanwhile, tail-end specialist Hollyport Capital has launched its latest fund, Hollyport Secondary Opportunities VI, and is understood to be seeking as much as £400 million ($500 million; €473 million), more than twice the size of its predecessor.

Tail-ends, which are defined by Greenhill Cogent as funds which are, on average, 10 years or older, represented 55 percent of the total vehicles marketed in 2016, according to data from the advisory firm. This was up from 48 percent in 2015.

It’s easy to see why tail-ends account for such a large portion of the market. Sellers, including pension plans and – increasingly – funds of funds and secondaries firms, are using the secondaries market to clean up and shut down old funds. For buyers, a portfolio nearing the end of its life should generate a return more quickly than a less mature one.

Buyers also have visibility on the assets. “Because the portfolio is so old, you have a sense of what the true value is at that point,” said a frequent purchaser of such portfolios based in New York. But while the “true value” may be easier to ascertain, the potential for net asset value growth is more limited, meaning buyers need to earn their return in two ways: discounts and leverage.

“Most of the return has to come from the use of leverage and the discount you’re getting at entry,” said Vladimir Colas, co-head of Ardian USA, although he would not comment on the Ardian portfolio currently for sale.

As for the discount, portfolios of tail-end funds tend to trade at around 60 percent to 70 percent of NAV, as opposed to 90 percent for younger buyout funds. Securing leverage can be a challenge, but when a portfolio is large – in the hundreds of millions of dollars – it will often be more diversified by manager, geography and vintage than a similar-sized set of less mature fund stakes. It will contain a greater number of smaller stakes, which means the lenders are more comfortable. Deals go ahead at a higher loan-to-value rate than other portfolio sales (as much as 65 percent versus as much as 40 percent, say sources).

But with that diversification, however, comes more risk.

“When you have 100 funds with $2 million of NAV each people might not figure out at what price each company is going to exit, because it’s so much work for such a diversified portfolio,” Colas said. “So some people take more of a statistical approach and look more at the vintages and the distribution profiles. In our view, that’s where the use of leverage becomes very dangerous.”

Colas explained that if potential buyers don’t have a view on the underlying company and don’t speak regularly to the GPs to establish their timeline for exits, they risk making assumptions about distributions that will not be fulfilled.

Tail-ends, then, are not for the faint-hearted. They are, however, set to become a more important part of the landscape, according to Colas. “When you look at the pipeline that’s happening now particularly in the US,” he said, “we’re seeing an increasing amount of tail-end portfolios on the market.”

Assuming credit conditions remain benign, it looks as if these kinds of sales will dominate the market this year.

Aside from leverage and discounts, what other plays can secondaries buyers make when buying tail-ends? Email me: marine.c@peimedia.com

 Let me know what you think: marine.c@peimedia.com