New generation GP-led deals

Are these the game-changers of Secondaries?

The secondaries
market has evolved
significantly from
its plain vanilla roots,
with the rise of GP-led
deals offering new scope
for activity.

So how do investors view these
transactions? And how pervasive might they become?

GP-led secondary transactions may have been in existence for many years now, but their more recent incarnations have made them something of a game-changer for both LPs and GPs.

Once a market for zombie funds and more troubled fund managers, these deals are now more likely to involve a GP’s best performing companies, in particular as the market has moved increasingly towards transactions involving a small number of assets (“concentrated multi-asset portfolios”) or even single assets.

Often badged by their proponents as a “win-win-win” situation, GP-led transactions are allowing GPs to hold on to businesses with further upside potential while giving a liquidity option for existing LPs and a deal opportunity to new investors.

Many LPs are welcoming the flexibility these deals can provide. “The evolution of GP-led deals is positive overall for LPs,” says J David Enriquez, Head of Private Equity at New York City Retirement Systems. “Concentrated portfolios or single asset transactions offer LPs optionality – they can choose to roll over, sell or remain with the status quo and we’ve opted for all three over the years.”

And their use has been growing significantly: in 2013, these deals accounted for just 7% of overall secondaries market by volume for a value of US$2bn; last year they took a 44% share of total secondaries volume, with a US$26bn value, according to Greenhill figures.

Holding up the market

Indeed, GP-led deals were largely responsible for keeping the secondaries market active last year as the value of more traditional sales of LP interests slowed down considerably in 2020, due in large part to a “dearth of large LP portfolios”, according to Greenhill. “Last year was similar to what we saw in the Global Financial Crisis, when the LP market collapsed by around 50%,” says Carlo Pirzio-Biroli, CEO and Managing Partner at Glendower Capital. “The same happened in 2020, but the difference this time was that GP-leds held up overall activity levels.”

Part of this slump in more traditional activity may be because concentrated portfolios and single asset deals are easier to analyse at a time of uncertainty than more diversified LP interest deals.

There have also been fewer issues with the denominator effect than in previous downturns because LPs are more likely to have a range built into allocation targets nowadays and because the public markets have largely remained strong through the pandemic.

Yet there is also a sense that investors may have learned from previous experience that selling fund interests in a challenging market is far from optimal.

“There is much wider recognition this time around that it’s often better to hold illiquid assets than to sell and that those that did sell in the last trough probably made a mistake,” says Steve Moseley, Deputy CIO and Head of Private Markets and Alternative Investments at Alaska Permanent Fund Corporation. “That’s why this time, there has been a freeze while investors get their arms around the situation. It surprised us a little as we had originally thought there would be a great opportunity to buy – but nothing really materialised.”

In a way, LPs have been hobbled in the market because they have no competitive advantage versus secondaries funds. LPs have limited resources and LP trades are not facilitated by GPs in the way that co-investments are.

- Steve Moseley, Deputy CIO and Head of Private Markets and Alternative Investments at Alaska Permanent Fund Corporation

Return of LP interests?

The expectation is that LP secondary transactions will pick up again this year and beyond as pricing stabilises and as the effects of the pandemic trickle through the economy. “The LP market will swing back – it just needs a year or so for the market to absorb the shock and normalise the bid-ask spread,” says Pirzio-Biroli. “We’ll see a US$100bn secondaries market for at least the next three years. There are strong tailwinds on top of the growth of the expansion of GP-led transactions: overall private equity asset under management growth to US$5tn, a continued deterioration of the ratio of distributions to calls we’ve seen since 2015, plus COVID-19-induced volatility layered on top. All this points to an increased requirement for liquidity in the secondary market.”

But there is a genuine buzz around the development of GP-led deals and the possibilities they open up for LPs. “In a way, LPs have been hobbled in the market because they have no competitive advantage versus secondaries funds. LPs have limited resources and LP trades are not facilitated by GPs in the way that co-investments are,” says Moseley. “As a result, the real excitement in the market for me is GP-led deals.”

For many investors, the GP-led secondary market provides an elegant solution to the sometimes arbitrary need to sell assets within a fund’s 10-year life but without altering private markets’ tried and tested fund structures. As Enriquez explains: “As an LP, I like the 10-year fund life because it creates a sense of urgency for value creation plans and builds strong DPI. If you put the same asset in a long-dated vehicle, this urgency would be lost. The good thing about GP-leds is it adds flexibility – a GP won’t know which companies will be the crown jewels when they first invest. The ad hoc basis of GP-leds allows GPs to identify which assets they want to own for longer.”

Keeping it in the family

LP demand and the attractive features of the market means that GPs are increasingly becoming repeat deal-doers. “Once GPs have completed one of these deals, they tend to consider doing more,” says Valérie Handal, Managing Director, HarbourVest Partners. “And while their first deal may sometimes require a change of mindset, we are seeing more and more GPs becoming repeat users of continuation funds for high quality assets they want to continue investing in.”

Yet while this may benefit all involved in the individual transactions, it may make due diligence and fund selection a little trickier in future.

“LPs will need to be careful to monitor how many GP-leds are at each firm over the coming years,” says Nicolas Schellenberg, Managing Director, Cambridge Associates. “In an extreme scenario, you might have a portfolio of, say, 10 single-asset deals being managed by a small team. You’d have to look at how they are motivated for their next fund and look at how long they might need to wait for carry on these deals. When it comes to track record, too, you’d have to look at how it all fits together. These are questions for LPs a few years down the line.”

This shouldn’t detract from the attractiveness of these deals, however. Schellenberg adds: “GP-led deals are here to stay and they will remain at high volumes. This will be the case even after the pandemic-driven uncertainty, when traditional LP interest deals return, because they are a strong addition to the private markets.”

Overall, the continued development of liquidity routes for GPs and LPs looks set to continue, with further innovations to come, says Handal. “The definition of secondaries is broadening, but at its core, the market provides liquidity solutions to investors in illiquid assets, and it is a continually evolving space offering new types of deals and opportunities,” she says.

And the result may well be that LPs can forge ever stronger, even more symbiotic, connections with the fund managers they choose to back, helping private markets develop further, while generating attractive returns.

“The GP-LP relationship is evolving as LPs are seen as a natural capital provider to meet GP needs,” says Dadong Yan, Portfolio Manager, Alternative Investments, MassMutual. “GPs need customised solutions from single capital sources and so they are increasingly asking for bespoke funding solutions, where institutional investors have the potential to add significant value. They can partner creatively at the GP level to help fund succession planning, launch new strategies and grow inorganically.”