Waiting for the boom

Secondaries buyers and advisors have been betting for several years that the market for GP-led transactions is about to explode. To date, however, they have struggled to make these types of deals attractive to limited partners.

According to data produced by UBS and seen by Secondaries Investor, the percentage of total secondaries transactions volume accounted for by GP-led transactions has been dropping year on year. It was 28 percent in 2014 and dropped to 26 percent in 2016. It’s not an earth-shattering drop, but it’s a far cry from the growth that many predicted.

Buyers like GP-led transactions and it’s easy to see why. Although GP-led deals may be more complicated and take more time to close than LP fund transactions, they provide greater returns.

UBS found that two-thirds, or 67 percent, of about 100 secondaries buyers expected returns from GP-led transactions to be more than 20 percent. Only 24 percent of respondents expect similar returns from the purchase of LP fund stakes.

This explains why some buyers have raised money dedicated to the strategy. Most recently, Intermediate Capital Group closed a fund targeting GP-led transactions, ICG Strategic Secondaries Fund II, on more than $1 billion. The firm, which has already completed at least two fund restructurings out of the new fund, declined to comment. Other firms are also placing a greater emphasis on those deals.

But one of the factors that has so far prevented the explosion of the GP-led market is LPs’ views of the practice.

California Public Employees’ Retirement System derailed the restructuring of a fund managed by First Reserve last year, citing inherent conflicts of interest.

In a separate example, the managing director at a GP that has undergone a recent fund restructuring told us that one of its LPs, a large US public pension plan, refuses to participate in nearly all GP-led restructurings presented to it.

LPs have long complained that in some GP-led transactions, particularly fund recapitalisations and fund restructurings, buyers are presenting them with two bad options: being forced to sell at a price they might not agree with, or roll into a new fund with new terms, which could involve a reset of management fees.

The secondaries market has made some progress in addressing those issues, but the solutions all have limitations.

For example, GPs can offer a third option to LPs: the status quo option allows investors to remain in the fund but under the terms they agreed to when they first committed. However, it can be challenging to maintain those terms for an LP when assets have been transferred to a new fund with new terms.

Despite efforts from some buyers to include these options in their transactions more frequently – and several advisors telling us that their use has become the norm – the data from the UBS survey tells a different story. The survey found their use dropped from 83 percent in 2015 to 66 percent in 2016, showing the status quo option may not be as easy to implement as initially thought.

With LPs pushing back on GP-led restructurings, the market has increasingly turned to tender offers. According to the research, tender offers represented 39 percent of total GP-led transaction volume in 2016, up from 33 percent in 2015.

However, an advisor noted that while tender offers may be friendlier to LPs, GPs are far from seduced by them. “You can’t really make the changes you need to be made,” he said. “It’s not for everybody for sure. But it’s a path of least resistance.”

Market participants remain confident that GP-led restructuring and recapitalisations will take off in the near future, but for that to finally happen, fund managers will need to improve their awareness of LPs’ needs during negotiations.

What will it take for LPs to warm to GP-led restructurings? Email us at marine.c@peimedia.com.