This year is shaping up to be another record year for private equity secondary market activity, globally. Already, worldwide secondary market transactions for the first six months of 2019 has been estimated at nearly 900 transactions, worth some $46 billion.
And the market is expected to continue growing, said Jeff Akers, Partner and Head of Secondary Investments at Adams Street Partners, a private markets investment firm. “The largest driver continues to be the increased acceptance of the private equity secondary market as a portfolio management tool,” Akers told DealStreetAsia.
“With average market prices in the mid to high 90s for buyout funds, primary fundraising growth over the last 5-7 years, and LPs looking to actively manage their portfolios, the ingredients are all there for continued secondary market growth. This has only been enhanced in recent years by growth in the GP-led market, which now accounts for nearly a third of the total market volume.”
Adams Street, which has $40 billion in assets under management, has been investing in secondary transactions for 33 years. In their observation, North America, as the world’s most mature private equity market, continues to be the largest source of deal flow in the market. At the same time, the type of transactions that have seen the most active growth has been GP-led.
“GPs are organising secondary transactions late in a fund’s life to allow investors a liquidity option, and to extend the life of assets they deem to need additional time to maximize value,” Akers said.
What’s the outlook for the secondary market for 2020, and beyond?
We believe the secondary market is poised for continued growth. Given the amount of primary fundraising over the last several years, there is a significant inventory of funds that are likely to trade in the secondary market. We believe GP-led transactions will continue to increase in popularity, which could substantially grow the market even further. One risk on all investors’ minds is the next market correction, which would lead to a temporary slow-down in broad market activity as the spread between bid and ask needs to close. We do not look to predict the timing of corrections, but we generally tend to see market dislocations as a time to be overweight given that high-quality assets can be found at deeper discounts.
Does being late in the economic cycle affect the market for secondaries?
Despite being “late-cycle” for the last 3-4 years, pricing has persisted in the mid to high 90s for buyout funds. We continue to be surprised at the number of secondary deals that essentially capture levered beta. We have seen some softness in the market in the last 6 months, which has resulted in portfolios that traditionally traded as a package to a single buyer getting broken up amongst several buyers.
Amid the boom, are there risks looming? What are they?
We are now approaching Year 10 of a bull market. While near-term economic signals look positive in parts of the world, we are investing defensively in anticipation of a market pullback. We are active in the GP-led space, though very selective to identify opportunities where we have strong alignment with the GP. Our sense has been that alignment has been lost in certain recent GP-led transactions that we’ve observed.
Seems the traditional discounts to NAV etc are narrowing. Why are buyers today willing to cough up?
Discounts have been quite narrow for the last several years, but in the last 6 months, we have begun to see some softness in pricing. At Adams Street, we are focused on price relative to our view of intrinsic value, not just discount to NAV when the transaction closes. And while discounts across the market might be narrowing, our price relative to NAV has actually remained consistent since 2012. In addition, a majority of secondary assets we track have appreciated post-transaction, showing that there’s still plenty of value to be derived in the market even as discounts tighten for certain portions of the market.
As LPs seek liquidity, and as fund cycles come to an end, we are seeing a lot of PE firms opt for sponsor-led secondaries. How do you view sponsor-led secondaries?
In recent months, we’ve often spoken about the future deal flow of GP-led transactions, and it’s a topic that was top of mind during our recent trips to Tokyo and Seoul. We have seen dramatic growth in GP-led secondary transactions within North America and Europe over the last three years. Most of these transactions involve funds relatively late in their life – typically when a fund is between 9 and 12 years old. We would expect that as the Asian private equity market matures, we will see more GP-led activity out of Asia. Still, over the last couple of years, we have seen and completed several GP-led transactions that leverage our deep GP relationships in Asia.
When it comes to LPs’ allocation to secondary funds, has it changed in recent years? Are we seeing more private equity investors consider secondaries as an integral part of their PE portfolios?
Secondaries continue to be an attractive allocation for investors. Historically, many investors were attracted to the asset class due to its structural benefits – J-curve mitigation, short duration, quick deployment of capital, and immediate diversification. These benefits are still an important thesis. But we believe secondaries have become a core holding for many LPs given the increasing opportunity set, distinct market strategies, and overall risk/return profile.
Has the WeWork wreckage spurred secondaries investors to reflect on how to value ‘disruptive companies’?
The recent volatility of unicorn valuations, particularly for cash flow negative companies, has definitely demanded the attention of secondary buyers. At Adams Street, we have always emphasized proven products and business models at reasonable valuations in the technology space. That focus has felt very good given the volatility we have seen recently.
In today’s environment, we are specifically emphasizing transactions that have underlying companies with higher growth rates, lower leverage, and durable business models. Given our ability to actively select specific managers, we are also able to minimize exposure to cyclical sectors in this late-cycle environment relative to broadly diversified portfolio deals.
Today, we are seeing sovereign wealth funds, pensions & family offices also pick up secondaries. Do you see these non-traditional buyers as competitors?
Several of the largest investors in the world have participated in the secondary market as buyers. They tend to be most competitive on the basis of the cost of capital and/or when they can leverage their size. Since we take a very targeted approach to our deal-making, we rarely run into these non-traditional buyers in a competitive context. In fact, we are more likely to be partnering with them on various opportunities.
Is ‘transparency’ the biggest challenge when it comes to secondaries? Are there enough data points, or analytics, in the case of PE investments, to help dealmaking?
Transparency is one of the biggest opportunities in private markets. For those secondary buyers willing to do the work to create a clearer picture of the underlying managers and their portfolio companies, there is a tremendous opportunity. Adams Street has invested heavily in technology and analytical minds to leverage our 40 years of cash flow data and real-time portfolio insights. Access to this long-term data provides a significant advantage as it enables us to efficiently analyze a very wide range of opportunities, and then selectively choose managers in which we have the highest conviction.
In the secondaries space, what is your take on team and portfolio spinouts and carveouts?
Given the evolving private equity landscape, it has been our experience that there are probably fewer spin-out opportunities today than there were 5-10 years ago when we saw several financial institutions needing to retreat from private equity.