How is COVID-19 affecting the secondary market? What best practices should LPs consider when selling their fund stakes in this uncertain environment? We cover those topics and more in this recap of our conversation with prominent players in the space. Our Head of Strategy here at Palico, Claire Commons, got insights from David Chu at LACERA, Anthony Le from Nokia Investment Management Corporation, and Gerald Cooper from Campbell Lutyens. • 6 min. Read •
While Covid will likely affect both volume and pricing, the recovery should be swifter than post-GFC because the overall market has matured and expanded significantly in the past decade. In addition, sentiment has now shifted with the LP community now actively managing/rebalancing their PE portfolios through the secondary market.
Secondaries as a widely-used portfolio management tool
Secondaries have come into their own as a portfolio management tool and as uniquely versatile. Private equity is one of the least liquid areas of most investors’ portfolios but the growth and evolution of the secondary market is creating flexibility and liquidity for the asset class. Given the volatility in global financial markets investors are understanding how secondaries can help rebalance PE portfolio allocations, make shifts in investment strategies, wind down non-core managers, or take advantage of a certain pricing environment.
David Chu, Senior Investment Officer at LACERA agreed noting that his pension fund has used the secondary market in a similar manner on the sell-side. He has also recently been participating in the GP-led transaction market on the buy-side, using secondaries to bridge gaps in their portfolio and efficiently increase exposure to the asset class.
Nokia’s private equity manager, Anthony Le, shared the importance of creating a well-designed secondary strategy: “[Nokia] uses [secondaries] as a portfolio management tool to rebalance the existing portfolio and bring our PE asset class weight closer to our target allocation, reduce our exposure to non-core PE managers, and use those proceeds to invest in assets that the team thought could earn higher returns.”
Once a sign of distress or poor manager selection, secondaries are now widely used by LPs as a means for active portfolio management. Gerald Cooper, who runs the secondary practice at Campbell Lutyens, underscored this idea by adding that 95% of Campbell’s LP-led transactions were driven by “some sort of portfolio management rationale” and that he sees “a lot of repeat sellers these days”.
Tips and Best Practices for a Successful Sale on the Secondary Market
Since the secondary market has continued to grow and mature, there is increased interest and curiosity from a broad array of LPs considering their first secondary transaction. The panel discussed some tips and best practices for those LPs considering a sale.
Commons, Head of Strategy here at Palico, emphasized the importance of establishing an efficient and streamlined process to manage the transaction, a critical component of Palico’s digital marketplace: “As an online platform, Palico’s strength has always been connecting people efficiently and making these processes less painful with an online data room and a secure chat function. This streamlined process, on top of Palico’s competitive bidding, solves that pain point of connecting a seller with a wide buying pool.”
Both Chu and Le noted the importance of thinking ahead prior to a sales process. Part of this analysis, according to Nokia’s Le, should include consideration of portfolio construction post-transaction. “[You need to] understand what your portfolio would look like post-transaction […] especially in terms of exposure across vintage years, sub asset classes and cash flows” when considering a sale.
Cooper stressed the “importance of understanding the risks when entering into an agreement with a buyer […] and always thinking ten steps ahead, preparing for the things that could go wrong in the process”.
COVID-19 may affect pricing and volume, with clear winners and losers
All panelists agreed that LPs are currently taking steps to assess how their private equity portfolios will be affected by the crisis. There was broad consensus that certain assets (tech, healthcare) will be more Covid-resistant, and therefore more attractive, whereas other strategies will struggle to find wide interest among buyers. In addition, higher quality names will continue to garner interest, but more obscure positions may find fewer bids. Positions with significant uncalled capital may also be a win-win in this current market.
LACERA’s David Chu highlighted the importance of focusing on sectors less affected by COVID. “A new investment criterion for everyone is ‘COVID-19 resistant’ and thinking more about the downside is a theme we are focused on in this environment. We are on the sidelines until things get repriced” says Chu. Anthony Le emphasized that high-quality GP names are continuing to price well but that he sees some downward pressure for tail-end funds.
Cooper noted the pressure on large, complex deals: “We have a few large transactions currently in the market on the GP-led side with assets that are resilient and in demand in this type of environment, but we are certainly not seeing the level activity that we were last year” says Cooper, who believes volume is currently at roughly $40bn, or 40% of where it was last year.
In the current environment, Commons sees interest in selling positions with a lot of unfunded capital. “It solves two problems: this unfunded liability that may be pinching the investor on the sell-side and, there is less negotiating or arguing around pricing on the buy-side because it is more of a liability.”
The secondary market will recover faster than post-GFC due to a more developed market and change in mindset among LPs
There was consensus among the panelists regarding expectations for a market recovery. First, with dry powder piling up on the buy-side and an increasing number of participants, panelists agreed that the market is better suited to cope with the crisis now than before. “Today there are over 70 buyers with dedicated capital to put to work in secondary funds. There are more solutions providers and the ability to craft different transactions is far superior in this environment than in the last crisis” says Cooper. On the sale-side, sentiment has also changed, with LPs increasingly viewing secondaries as a critical portfolio management tool: “There is a lot more acceptance of secondaries on the LP side” says Chu.
Palico is the leading digital marketplace for private equity secondaries. Our digital platform is designed for LPs, from single Family Offices to large Pension Funds, to streamline the secondary sales process, and maximize price with an array of both traditional and non-traditional PE buyers on the platform.