Secondaries

The secondary market is the home of three popular views today.

• You only invest in secondaries to mitigate the J-curve and get access to prior vintage years.

• GP-led secondaries are terrible, because GPs are selling their crappy assets.

• GP-led secondaries, particularly single-asset deals, are just like co-investments.

We’ll just note that the first can’t be true if the second and third are even remotely true, but nevertheless let’s use this section to dig into GP-led secondaries a little more and bring some reality into the discussion.

There is no question that the growth of GP-led secondaries is one of the biggest changes to the private markets landscape in the last five years.

GP-Led Secondary Market Growth

GP-led transactions have become a major part of secondary deal volume, in some years exceeding the number of LP deals. Remember these didn’t even exist eight years ago! Within the GP-led space, single asset transactions have also become a larger component of that sub-market. The reasons are fairly obvious: a desire to sell assets and give LPs money back; GPs wanting to retain some of those assets for a longer period; the economics for both GPs and for placement groups is lucrative.

There’s a great deal of chatter about the GP-led space, ranging from “these are wonderful deals” to “these are the worst deals in the history of private equity.” Let’s try to get some data to help us figure out what’s really happening.

GP-Led Continuation Vehicle Performance

BY YEAR OF INVESTMENT

Asset(s) Performance Prior to CV

Asset TVPI Prior to CV 

HOLD PERIOD PRIOR TO CV

The returns look good, although it’s early for most of these transactions. We’d also note that, from a return perspective, these transactions don’t seem to have any return premium to LP transactions. Should they? Perhaps given the greater concentration, they should. Can we draw any conclusions about these GP-led deals based on the characteristics of the fund from which they were sold?

We would have said, and bet you would have also said, that better deals are associated with higher prior fund multiple on invested capital and shorter holding periods – the theory being there’s more upside with the shorter hold in the fund. The opposite is what early returns suggest. You want to lean into a fund that has lower prior performance and that has been held longer.

The argument we hear all the time is that single asset, GP-led deals are the same as co-investments. Presumably, this means having them benchmarked as co-investments, having different teams work on them if you are structured that way and looking at them with a generally different lens than you do secondaries. Some of that is philosophical and a question of how you organize your team, but are there return profiles that suggest they are the same or different?

“Co-Investment” vs. Single Asset Continuation Vehicles

From a pure IRR perspective and using the buyout index as a proxy for co-investments, buyout deals have outperformed single asset, GP-led deals. Even if you take out fees from those buyout numbers, you would have somewhat outperformed single asset deals. You can see that in the chart above, which exhibits TVPI comparisons. The differences in return are marginal between the two categories. What does appear quite different is the risk profile of the two. The bucketed MOIC bars show that single asset deals have had a much tighter return band and lower loss ratios.

What’s our conclusion on these single asset deals, particularly versus co-investments? We don’t believe they are the same. To start, these are not lousy assets as the market feared. These are assets that general partners want to keep. This means they are probably safer, lower-returning assets with far less downside than other secondary or co-investment assets in your portfolios. It requires that we re-think how they are put together in portfolios but it also, we believe, requires that they be in portfolios. It is a type of asset that is unlikely to find its way into either your primary or co-investment portfolio.

We will say again, at the risk of boring repetition from prior market overviews: You need to be investing in secondaries, regardless of the current make-up of your portfolio.  Not doing so will cause your portfolio to lose out on opportunities that generate superior returns. It really is as simple as that.