First Annual Secondaries Outlook

Our panel of General Partners (GPs) included:

• Eric Foran, CFA, Partner, Coller Capital

• Cari Lodge, Managing Director, Commonfund Capital

• Barry Griffiths, Ph.D., CFA, Partner & Head of Quantitative Research, Landmark Partners

• Brett Hickey, Founder & CEO, Star Mountain Capital

• Victor Wu, Partner, Lexington Partners

• Moderator – Leor Landa, Partner, Davis Polk & Wardwell LLP

We also heard from a panel of Limited Partners (LPs) with knowledge and experience unique to Secondaries investing:

• Jeremy Klepner, Vice President, Jasper Ridge Partners, L.P.

• Sander Doucette, CFA, Director of Investments, Hamilton College

• Michael Nelson, JD, CFA, Managing Partner, Eagle Bay Advisors

• Moderator – Michael Catts, Managing Director, Evercore

What are “Secondaries” ?

First a quick primer – not everyone may be familiar with the term “Secondaries” and the distinguishing features versus the typical manner investors deploy capital into Private Equity or Direct Lending.

Simply stated, Secondaries are a mechanism for investors to buy into Private Equity, without having to lock up their money for the typical 10 year or longer horizon when they buy into a new and recent fund.

The secondary market was originally defined largely by the sale and purchase of Limited Partner interests in individual private equity funds or portfolios of funds, albeit only after a number of years “aging” into the life of the PE fund. Purchasers acquired investors’ interests in the funds’ remaining assets, and agree to take on the remaining commitments to meet future capital calls.

To illustrate: Limited Partner Susan buys into a PE fund, buying the stake from Limited Partner John who wants out from a PE fund in year 5. For Limited Partner Susan, a secondary purchase has a number of desirable benefits – the opportunity to own Private Equity seasoned 5 years into the life of a PE fund – which provides a degree of visibility into the underlying composition of portfolio companies performance and value creation in progress. Susan is also likely to have most or all of her money returned back to her via distributions much sooner than if she had invested in the hottest new fund being raised today.

In the recent decade, the approach described above has produced remarkably strong results for investors.

Looking ahead, the Secondaries market is expected to re-shape and evolve as it continues to mature and grow. Here is some of what we heard from our panelists:

(1)  Secondaries are no longer a well-kept secret

The secondaries market has grown exponentially. Volume and frequency of buyer / seller transactions is sky high and still growing. A hefty supply of eager investor capital is pouring into dedicated Secondaries funds, including a handful of $10 + billion “mega-funds”.

Among our panelists, there was a unified view broadly that today’s Secondaries market is far more competitive and commoditized versus the past decade. Investor returns within Secondaries will likely compress lower as compared to the experience looking back over the last 10 years.

(2)  In a crowded market, creative solutions can still extract compelling opportunities

Despite the flood of capital and competition, attractive return / risk propositions can be extracted from today’s secondaries market – with a bit of ingenuity and willingness to find unique pockets of opportunity.

For example, focusing on the smaller end of the market, “tail end” fund assets well beyond year 10, and negotiating more bespoke non-sponsor transactions are levers for secondary buyers to acquire stakes at steeper discounts to NAV (And thus higher implied returns).

Landmark Partners has made a calling card developing and establishing various structured transactions addressing key buyer and seller needs. Structuring situations and motivations of a buyer and seller look quite different one from the next, but the commonality of structured transactions often is the ability to earn a preferred rate of return with defined downside and upside to the investment over a stated period of time.

(3)  Secondaries funds of the future will bear little resemblance to the past

The lines and boundaries of the secondaries playing field are being re-drawn, as is the playbook used by investors in the secondaries arena. Expect the state of transformation to continue.

Activity and exposures underneath the hood in secondaries funds historically centered on Buyouts – underlying assets that are more mature and predictable, requiring less guesswork to gauge and estimate value in the underlying portfolio companies. Today, secondary funds are exploring, consuming, and digesting stakes into many new types of assets with markedly different characteristics (Venture Capital, Emerging Markets PE, et. al).

Another evolution to keep an eye on is the growing prevalence of “GP Led Transactions” – complex deals, some of which have come under scrutiny from regulators, and are often characterized as opaque and fraught with potential conflicts.

Looking ahead, expect far more dispersion among the returns of secondaries managers. The top flight players with discipline and domain expertise are likely to distinguish from the bottom of the pack. 5 years from today, managers could find themselves much more vulnerable to ruin within their results, prompted by the many new and unfamiliar risks permeating into secondaries portfolios.