Secondaries can be a highly useful tool in an Asian fund manager’s toolkit as global market corrections persist and dislocations emerge, shared global investors at a SuperReturn Asia panel on Wednesday.
Secondaries refer to the buying and selling of preexisting private equity investor commitments to private market funds.
The Asian secondaries market has come a long way in the last 10-12 years, with limited partners (LPs) and general partners (GPs) displaying greater sophistication in their approach toward secondary solutions for their portfolios. The ‘stigma’ around secondaries has also largely faded among Asian fund managers, with many increasingly viewing it as a value-accretive solution which can align LP-GP interests.
The ‘stigma’ around secondaries has also largely faded among Asian fund managers.
“The sophistication in Asia is at a high level. I don’t think there’s a difference in the sophistication of deal types that you see in Asia versus what you see in the West,” said Arjun Bawa, partner and head of Asia at Fairview Capital Group.
Given the relative nascency of Asia’s private equity sector compared to the US and Europe, many LPs with exposure to Asia have yet to see strong cash or Distribution to paid-in (DPI) returns on their Asian portfolios.
The current market conditions will likely drive demand for such secondary solutions to unlock liquidity, particularly transactions which are more active in nature, added Paul Robine, founder and CEO of TR Capital Group.
This is raising the bar for Asian secondaries market as a whole. “Ten years ago, you could run a secondary business from Hong Kong or Singapore. Those days are over,” said Robine. “Today, you need to have on-the-ground presence with local teams in China, India, and Southeast Asia.”
The maturation of the secondaries market will also bring about a “dispersion” within secondaries as a category, commented panelists. This wouldn’t simply apply to fund performance across vintages, but also in terms of sub asset-classes like GP-led, LP secondaries, and structured equities, with each bringing about its own unique set of risk-returns, shared Yann Robard, managing partner at Whitehorse Liquidity Partners.
GP relationships will also play a crucial role, driven by the growth in GP-led secondary transactions in recent years.
“GP relationships are going to become even more important than they have been in the last 10-12 years,” predicted Pinal Nicum, Partner at Adams Street Partners.
“The best transactions are access-constrained. The best GPs – just like on the primary side – are picking and choosing who they work with in the secondary market today. So I think those things are going to continue,” he added.
The panel discussion “In Search of Liquidity: Unpacking the Complexities of the Secondaries Market” took place at SuperReturn Asia in Singapore on Wednesday.
The panellists were Pinal Nicum, Partner at Adams Street Partners; Paul Robine, founder and CEO of TR Capital Group; Yann Robard, Managing Partner at Whitehorse Liquidity Partners; and Arjun Bawa, Partner, Head of Asia, Fairview Capital Group. The discussion was moderated by Yash Gupta, Executive Director at Morgan Stanley.
The transcript below has been edited for clarity.
What has happened and changed in the secondaries market over the last three years?
Bawa: As liquidity has dried up, the secondaries market has stepped up its game, they’ve really sharpened their tools and brought solutions to the private equity market, and that’s been very impactful.
The biggest change has been in GP-led transactions in Asia and globally. They’ve provided a solution for creating liquidity for GPs. The LPs had expectations of capital going back and when exit windows closed, the secondary market really stepped in to provide solutions there.
“As liquidity has dried up, the secondaries market has stepped up its game.”
Another big change is that there used to be a big stigma against doing GP-led secondaries in the minds of GPs and LPs. That’s dramatically changed. So, we’ve seen these deals proliferate, not only across the larger end of the spectrum with mega buyout funds but equally with small and mid-market funds, regional funds and venture capital.
Yet another change has been the supply of capital. We’ve seen the supply of capital increase many fold over the years. I’m not just referring to the quantum of capital but also the nimbleness and diversity of capital. You see fund of funds, secondary specialists, Asia-focused secondaries, hedge funds and event asset managers become credit providers. So that diversity of capital has really brought a whole different set of solutions for unique problems that a portfolio can run into.
We’ve talked a lot about GP-led secondaries and a little about LP secondaries, but what about other types of secondaries? Yann, your fund provides some interesting solutions which complements a lot of the stuff that we’re seeing in secondary markets.
Yann Robard: What we’re trying to provide at Whitehorse are alternative ways to generate liquidity for PE portfolios. What’s really interesting is that there are lots of innovations happening in the secondary market, including preferred equity or structured liquidity solutions.
In some cases, when the markets went down in 2020 and the secondary market shut down, the ability for people to generate liquidity on their private equity portfolio would have required a significant discount. This gives a new tool for people to be able to tactically re-allocate their PE portfolio, while keeping the upside and flexibility.
“There are many innovations happening in secondaries, including preferred equity or structured liquidity solutions.”
So our focus at the end of the day has been to give more tools in the toolset. There’s a lot of innovation happening with the growth of this market.
I think everyone on this panel really thinks of secondaries as problem-solving capital. Pinal, let’s talk about different geographies broadly. What’s going on in the US and Europe?
Pinal Nicum: I think from an LP transactions perspective, the US and Europe still represent the lion’s share of activity. When we talk about US/Europe, we’re really talking about who the sellers are, the jurisdiction of the sellers and also the underlying assets being sold. PE is still heavily-focused toward the US, and to a slightly lesser extent in Europe.
I think in some respects, Asia has probably lagged a little bit in my growth expectations in the secondary market. I probably sat on this panel 10 years ago and projected that 5-10% of the overall market will be in Asian secondary transactions. Last year, the market was about $120-130 billion, but Asia represented about $7 billion of that. So it’s still in that 3-5% range that we were seeing 10-12 years ago.
One area where there is potential for growth to accelerate is in the GP-led segment. We’re seeing GPs in this part of the world be very resourceful and forward-thinking in terms of how they can use the secondary market.
“About 20 years ago, the secondary market used to be seen as a nuisance and it’s obviously gone full circle now…and nowhere more so than in Asia.”
I remember about 20 years ago, GPs were usually the last people to find out that an LP was selling a position in their fund, and they were usually not happy about it. The secondary market used to be seen as a bit of a nuisance and it’s obviously gone full circle now…and nowhere more so than in Asia.
What do you think about different geographies within Asia?
Nicum: The two largest PE markets in Asia have been China and India. Historically, secondaries are just a function of what is raised in the primary market. The pan-Asian funds with some Southeast Asian exposure is a growing segment as well. I think given some of the challenges at the moment, including geopolitical risk and regulatory risks in China, could drive more activity in the short term. I’ve been meeting Indian GPs over the last few days, and they’re pretty excited about the opportunities that this is going to bring over this coming period.
Paul, your firm focuses exclusively on Asia. I’d love to hear how Asia has developed from a secondaries perspective.
Robine: The market has really changed in the past 10 years in that it has grown, that’s number one. Number two, the opportunity has shifted from traditional LP secondaries which are passive in nature, to more active secondaries. Thirdly, the bar has increased for secondary players. Let me explain.
If you take the unrealised value, which is owned by PE firms in Asia which are six years old and above, and are reaching the end of their fund life in the next 24 months, the aggregation of this value was $523 billion in 2021. In 2022, that amount will reach $1 trillion. So the opportunity has grown substantially.
The second point is that 10 years ago, traditional LP interest was interesting. Today, you have so many players that the discounts are lower. I will say the opportunity has shifted towards either direct secondaries where we acquire direct stakes in companies from GPs that wish to sell, or you do fund solutions that are a bit more complex, and you establish clear targets with the GP you’re acquiring the portfolio from. So there is a sophistication in the market.
“Ten years ago, you could run a secondary business from HK or SG. Today, you need to have an on-the-ground presence.”
One final point – 10 years ago, you could run a secondary business from Hong Kong or Singapore. Those days are over. Today, you need to have an on-the-ground presence with local teams in China, India and Southeast Asia. Look at the past three years where there were travel restrictions everywhere. If you don’t have a team in one of these geographies, how can you operate pre-deal? How can you operate post-deal? You need to have large teams, at least 20-30 people with several offices across the region, and only then can you operate in a professional manner. So the bar has been raised since 10 years ago.
Bawa: The sophistication in Asia is certainly at a high leveI. I don’t think there’s a difference in the sophistication of deal types that you see in Asia versus what you see in Western markets. We’ve seen every flavour of transactions — strip sales, staples of continuation funds etc. It’s because Asian PE is 25 years old and each one needs a bespoke solution.
Just to give an example, we did a transaction last year where the complexity was quite unusual. It was a fund which had a large amount of senior fund leverage from a fund lender, and it had some mezzanine. It also had some 100 different LPs sitting on the deal, and it was a fund that was stretching to 14 years and everybody wanted money. So it was truly a complex situation with multiple stakeholders all looking for liquidity. Interestingly enough, there was also a diversity of participants who wanted to buy that position and provide the liquidity solution. So I think the innovation in Asia is quite cutting edge.
“The innovation in Asia is quite cutting edge.”
Robard: If we start looking at the global secondary market over the last 2-3 years, PE in 2021 was a victim of its own success. Most LPs entered 2022 overallocated to PE, and yet were facing very strong fundraising and GP fundraising environment. So the LPs are sitting there saying they’re overallocated, capital constrained, but they didn’t want to miss a vintage.
So, in Q1 of this year, the secondary market was very busy. $53 billion was traded in the first half of this year, with most of them happening in Q1. And then Q2 happens, and the LPs are overallocated, the public markets go down which compounds overallocation. The distributions dry up, which compounds overallocation. Now the next shoe to drop is that the capital calls are gonna start to come in as a GP starts to clear their capital call facilities.
So you’re talking about a market where LPs have essentially been overallocated trying to figure out how to release the pressure valve to be able to commit to the next month. What happened was in Q2, the public markets faltered, anybody that was looking for liquidity at that point in time had to start taking a queue number. So there’s a long queue of LPs right now just now coming to market with their portfolios, because they had to wait until the Q2 marks came out. The Q2 marks came out in August, and now the floodgates have opened. So that’s what we’re experiencing from a global perspective. There is a flood of transactions in this marketplace right now.
Essentially what’s interesting from my perspective is that everybody talks about how much capital has been raised in the secondary market. But there’s actually only $94 billion of dry powder in the secondary market as of Q2. Last year, $135 billion was traded, $48 billion in the first half and $86 billion in the second half. If you take the first half, which was $53 billion and there’s pent up liquidity, then the second half should be as big as last year.
“There’s only 4 months left of dry powder in the secondary market. What other market has only four months of dry powder?”
That means that if there’s $94 billion of dry powder, there’s only 4 months left of dry powder in the secondary market. What other market out there only has four months of dry powder? If you then compound that with the fact that fundraising is difficult in this market right now for all GPs, and you’re saying that the secondary market is not going to recapitalise very quickly. Projections say about $111 billion was likely to be raised next year. That was before all of this volatility.
Let’s say that it’s harder to actually raise that capital. So $75 million gets raised. Remember that $134 billion was traded last year. So this is an undercapitalized market right now which leads to the next few quarters being a buyer’s market. So if you’re looking for liquidity in this market right now, what I would say as an LP is – manage your expectations. And if you don’t need to sell, you might want to try to hold on to it a little bit.
Robine: I would add just one observation that pertains to Asia. One of the issues faced by LPs who have been investing in the region for a while has seen growth and innovation, but they’ve also seen very poor DPI figures reported by funds. People are starting to see that the secondary strategy is addressing this issue, where you can generate DPI within the first five years of a fund’s launch. This is quite new in the region. It is, of course, about multiples and IRR but it is also about DPI.
Discounts in secondaries haven’t really existed for the last 10 years. But as we enter into the current market, are discounts going to come back? Especially with the innovation that is happening around secondaries?
Nicum: If you look back at past economic shocks or extended periods of downturn and the last 20 years of secondaries, there is a kind of “tried and tested” set of events that happened in the shocks, where there is a drying up of the market to a degree, but there are still transactions. They happen much more off-market in a bilateral way. We saw that very strongly in the first 6 months as we got out of COVID.
What tends to happen there is the seller psychology. They don’t want to accept big discounts, they would love to trade out of a significant portion of their portfolio, but realising that the discount spread is wide. And if they want to sell big books, they will lean towards trying to sell some of their better assets where the optical discounts would at least look smaller. So there are some nice cherry picking, mosaic opportunities, where you can buy subsets of portfolios.
“Selecting the right assets, and the right managers have never been more important than in volatile periods.”
Then you get a longer, multi-year period where, especially when you have things like we’re going to now – we’ve got a likely recession in the US or stagflation in Europe, geopolitical risk in other parts of the world. So we’re going to have a multi-year “clean up” where LPs will be looking at their portfolios pretty hard over the next 2-3 years, and you’ll have serial selling over multi-years. So absolutely, secondary buyers gotta live for these periods. You have to be selective and you have to know what you’re buying. Selecting the right assets, and the right managers have never been more important than in volatile periods and there should be some very good opportunities out there on the buy side.
Arjun, as someone who’s on the advisory side, what are you seeing?
Bawa: I fully agree with the broad perspective here, but I think there’s a small bifurcation in that I think there’s a different world in the GP-led transactions and the horses for courses. I think we’ve seen a lot of transactions in China and other parts of Asia that are traded in what the market would consider considerable discounts. There is a situation – and you will be seeing it increasingly in the venture space and technology investments in growth, equity, and VC, where discounts are pretty steep in Asia. At the same time, there’s also a willingness from the GPs and LPs to transact even at those volumes. And I think we see that not only for USD funds across Asia, but also in the RMB space as well. So I think there’s a little bifurcated space within the secondary market on discounts.
Yann, how do discounts or optical discounts change when you’re thinking about structured equity or price equity solutions?
Robard: I think what’s interesting is that it’s not just in bad times that structured liquidity solutions can work. Let’s talk about 2020. We were in a pandemic, the prices were reflecting that there was a lot of uncertainty, and a lot of turbulence in the market. In the US and Europe, generally speaking, things trade about 90 to 95, maybe up to par in good times. So in those market disruptions, you might get to the low 80s, and that might be too much of a discount for people to want to take on.
So the structured liquidity solution allows you to tactically reallocate, you would not get as much as you would if you would otherwise sell, but you don’t crystallise in discount, you don’t forego future proceeds, you don’t time the market. What you’re doing is that you’re tactically reallocating, and it allows you to essentially deal with your overallocation issue but keep the upside on the portfolio when it returns.
Then 2021 happens. 2021 was the inverse. Your private equity portfolio did too well. You are overallocated. So you might have a portfolio that says, look, I’ve actually experienced too much growth in my unrealised value, I’m over-allocated for a different reason and I need to tactically reallocate, take some chips off the table, and deal with that over-allocation. You don’t want to sell your portfolio because you like your portfolio, you like your underlying GPs, and you like the upside so you can see how this structured liquidity solution can work in good times and in bad depending on what the market environments are.
“If you’re looking for the trough, you’ll probably miss it. It’s about having consistent deployment in the eye of the storm when fear is highest.”
It’s not just about putting up a little bit of money at exactly the right time. If you’re looking for the trough, you probably will miss it. It’s about having consistent deployment in the eye of the storm when fear is the highest, so that you have capital to allocate during these periods of time.
Nicum: It’s not only in bad times that people think their assets are worth more than they are. That is a characteristic that you see in good times as well. People overvaluing their assets and looking for prices that are probably higher than you’d be willing to pay.
So the good thing about PE is that valuations are not uniform from fund to fund. GPs are involved in valuations, they have different policies, you have to understand what is going on over multi-years with a particular GP to get a sense of how they value their portfolios, how they underwrite their growth. You develop that conviction that allows you to buy both when markets look expensive in good times, and when markets look expensive in bad times. I guess the psychology of a secondary buyer is to try and find those value propositions in all markets.
Robard: Going back to our discussion on discounts, there are two ways to generate returns when secondaries investors acquire average quality assets at steep discounts. In Asia, we take the view that these are value tracks but it’s not necessarily a good space to be in because you may think you are doing a good deal at entry, but you will be stuck for 3-4 years, and these will be assets that will be quite complicated to exit.
The other way to generate a return is to focus only on high-quality assets, where yes, your discount may be just single-digit in normal times, but where your exit will be much greater. This is really a better space to focus on. In the past 2-3 years, the discounts for high-quality assets were around 10%. We start to see discounts widening to probably 15-20%. But good quality companies will never be cheap. And you’re paying yourself a price that is a little higher with a much greater certainty to exit.
“For Southeast Asia, the market is really growing as a secondary opportunity.”
For China, at the moment, with the release of NAV by firms for Q2, we’re beginning to see the lockdown effect. We’re starting to see NAV drop from the private market to the public market. But in the private space, it’s continuing. India remains quite expensive. For Southeast Asia, the market is really growing as a secondary opportunity. So all in all, it’s about selecting the right companies, making sure that you know your ability to exit within a timeframe of 3, 4, maximum 5 years. That’s how you generate returns.
Lastly, can you share your predictions for the secondary market?
Robard: So I put up a bold prediction that the secondary market will hit $1 trillion dollars by 2030 in annual volume. So I want to play mental math Olympics with you all over again.
If you think about last year, private capital was $12 trillion. Last year, the secondary market was $130 billion. That’s 1% of the private capital market. That 1% has to grow to 4% by 2030. To do 4% of $25 trillion, you get to $1 trillion by 2030.
“The secondary market will hit $1 trillion dollars by 2030 in annual volume.“
Why is it going to move from 1% to 4%?
You’ve got more LPs being active in the way they manage their portfolios, you’ve got the GP-led market that is not going to stop, GPs have figured this out and they’re using continuation funds to keep their best assets. You’ve got the GP stakes market and the secondary market that is merging in terms of the types of transactions. You’ve got new asset classes like private credit infrastructure, real estate, that’s all maturing and that’s going to add to that volume.
And lastly, the type of capital that’s coming into private is high net worth, retail – these folks need more not less liquidity. So I look at it and I say okay, 2009 was $10 billion, and now it’s 130 billion so we’ve done 13 times in the last roughly 13 years. So can we get to $1 trillion dollars by 2030? Yes, I think so.
Arjun, do you have a view on that?
Bawa: I certainly hope Yaan’s prediction relation comes through and I think it would be very close to that. One point I would make is that the Asian secondary market and Asian private market are quite disconnected.
“Asia’s share of the secondary market is going to be closer to 15% in the next five years.”
I think Asian private markets probably represent about 30% of global markets, and secondary markets about 5% of global secondary markets. I think that’s pretty dismal and I think that number is going to certainly ramp up. I think Asia’s share of the secondary market is probably going to look somewhere closer to 15% in the next five years. And I think it has every reason to get there.