Private equity secondaries—investing in GP-led transactions
The secondaries market for private assets represents a vibrant and growing opportunity for investors. What started as a niche market in the early 1990s has blossomed into a cutting-edge institutional asset class with annual transaction volumes soon set to exceed $100 billion.¹ Innovation has always been a hallmark of the secondary market, and today, GP-led secondaries have paved new potential paths to outsize returns for investors able and willing to commit flexible, solutions-oriented capital enabling private equity sponsors to extend the holding periods of their most prized portfolio companies.
Secondaries market origins and development: stigma yields to success
The modern secondaries market is a far cry from what it was 20 years ago. Transaction volumes in the early 2000s were fluctuating at low single-digit billions per year. That puts 2019’s $80 billion¹ in some perspective—what other investment markets have grown 40-plus times in two decades?
In the early years, transactions were dramatically smaller, participants were noticeably fewer, and variety was not the spice of life within the secondaries market. The sole reason secondaries existed was to provide private equity limited partners (LPs) with access to liquidity that became necessary as a result of some sort of stress. The wave of LP fire sales in the wake of the global financial crisis represents a prominent case in point; frankly, the secondaries market was viewed as uninteresting, and most people didn’t even know what it was. Those few who did tended to avoid it if they could. Private equity sponsors saw the secondaries market as a necessary evil, with participation of opportunistic vulture investors rather than the upstanding LPs who represented the bedrock of the business. Back then, the only interaction a sponsor would have in the secondaries market would be to reluctantly approve the transfer of an LP interest from an existing investor to an upstart secondaries fund.
Today, that old dynamic has been turned on its head. The unique value proposition of the secondaries market is now widely acknowledged by virtually all its stakeholders, including:
- Limited partners (LPs), who have gained access to liquidity allowing them to more actively manage their private equity exposure
- Secondary investors, who have gained an opportunity to pursue high internal rates of return (IRRs) and attractive multiples on invested capital (MOIC)
- Sponsors, who have gained a new portfolio management tool that allows them to hold high-quality assets for an extended period and continue to reap the rewards of their value creation
Secondaries represent a growing and vibrant opportunity for investors
Annual secondaries transaction volume in billions of U.S. dollars
The emergence of GP-led secondaries transactions
While the purchase and sale of LP interests have long become a legitimate tool for managing private equity exposure, a new use case has emerged that will almost certainly ensure the secondary market reaches new heights in the not-too-distant future. Starting slowly in 2012, and then accelerating in 2015, private equity sponsors began to actively solicit capital from the secondaries market in what has become known as GP-led secondary transactions. Their use of capital—to extend ownership of assets, raise new growth capital to support the assets, and provide near-term liquidity to LPs—has fundamentally changed the secondaries market. In our view, there are now two secondary market segments, each with powerful and unobstructed growth drivers.
Differentiators of GP-led transactions versus LP-led transactions
GP-led secondaries have three key characteristics that distinguish them from traditional LP secondaries investments.
1 The sponsor drives the transaction
GP-led secondaries allow a sponsor to extend ownership of a valuable asset by pulling it out of a maturing fund and moving it into a new fund. The change of ownership is funded by secondaries investors in a competitive process that takes the place of a traditional merger-and-acquisition transaction or initial public offering. It’s a mutually attractive proposition: Legacy fund LPs have the opportunity to take liquidity, the fund’s sponsor gets to retain control of the favored asset, and new secondaries investors potentially participate in the upside of the hard-to-access asset throughout the extended holding period, often an additional three to five years.
2 The underlying asset concentration is higher
A GP-led transaction often focuses on a single fund that holds relatively mature assets. A transaction usually involves transferring an asset or assets from the existing fund to what’s called a continuation vehicle. More frequently in recent months, sponsors have selected a single high-performing asset from an existing fund and offered it in the secondaries market through a newly formed special purpose vehicle known as a single asset continuation vehicle. Whether the net result is a vehicle containing one, four, or eight assets, the asset concentration in net asset value for the new secondaries investors in a GP-led transaction is significantly greater than for most LP transactions.
3 The transaction process is more complex
While LP transactions can be executed relatively quickly and efficiently, GP-led transactions take multiple months to complete. The greater concentration necessitates more and different kinds of diligence, often requiring third-party service providers to provide quality-of-earnings reports, market studies, and other vendor diligence activities. Moreover, GP-led transactions are multistage processes that typically require hiring advisors and procuring consent from existing LPs in lengthy, tender processes.
GP-led deals are driving the secondaries market to the next level
In 2019, the share of GP-led transactions grew to one-third of secondaries market volume. In 2020, the pandemic accelerated this shift, suppressing the volume of LP-led transactions while stimulating the volume GP-led transactions, which rose to half of all secondaries market volume.
GP-led deals represented a majority of secondaries in 2020
GP-led deal volume in USD billions ($), and as a proportion (%) of all secondaries
Five major investment banks got into the secondaries market advisory business in 2020 alone, further fueling growth. The rise of GP-led deals has continued, as sponsors have internalized the value proposition and have begun initiating secondaries transactions with increasing frequency.
Secondaries funds raised roughly $100 billion of the $600 billion raised for private funds in 2020. This is both the highest level ever raised by secondaries funds and the largest percentage of the private markets ever captured by secondaries. Despite this surge in funding for secondaries, knowledgeable market participants assert the secondaries market is still undercapitalized for GP-led deals, which begs the question, who’s going to step in and fund this growing deal flow? In our view, the emerging trend in the supply-and-demand dynamic puts secondaries investors in GP-led transactions at a distinct advantage.
A threefold value proposition for investors in GP-led deals
GP-led transactions carry a set of attributes that offer a distinct value proposition to market participants and have made them attractive to secondaries investors. The main elements of the value proposition are threefold: They allow for surgically precise portfolio construction, they offer an attractive risk/return proposition, and they create mutually beneficial value-added partnering opportunities with top-tier sponsors.
1 Better portfolio construction
GP-led transactions enable secondaries managers to construct portfolios with a greater degree of precision than is available in the traditional secondaries market of aggregated LP positions. While GP-led transactions’ higher concentration places a greater burden on diligence, it creates an opportunity to shape a secondaries portfolio by sector, geography, company stage, and risk type. This ability to curate a portfolio from among a wide variety of investment choices will broaden the return outcomes for secondaries market investors, potentially elevating those who select assets carefully over those who invest indiscriminately in an effort to play it safe by overdiversifying and achieving a sort of secondaries market index of returns.
2 Higher return opportunities
GP-led transactions offer an array of potentially higher-return investment opportunities relative to traditional LP secondaries investments. In today’s secondaries market, the typical LP portfolio transaction is underwritten at an unlevered 1.3x–1.6x MOIC and a 12%–16% IRR.²
The emergence of GP-led transactions in recent years has improved the risk/return trade-off for secondaries transactions, creating a new kind of secondary alpha. GP-led transactions offer the potential for unlevered MOICs of 1.7x–2.2x and IRRs of 15%–22%.² A skilled, active, informed, and diligent secondaries manager can access these returns by considered curation and construction rather than by ratcheting up risk.
3 More aligned investments
GP-led investments generally produce greater alignment between counterparties than traditional LP secondaries investments. An LP-led transaction sets up a price negotiation in a zero-sum game. The parties are trading risk positions with the result being that one party assumes full risk while the counterparty sheds it completely. By contrast, in a GP-led investment, a secondaries investor’s counterparty, the sponsor, continues to bear risk through its capital contribution to the investment after consummation of the transaction. This allows the secondaries investor to act as a capital partner to the sponsor, including potential follow-on investment opportunities that could become proprietary if collaboration and trust have been established.
What’s next for secondaries investors: private credit and more
Achieving liquidity for private assets isn’t a straightforward exercise, and the secondaries market has long been characterized by solutions-oriented transactions. Private assets have historically been held in a variety of structures by different types of investors with different needs and different constraints, and this constant push for innovation to achieve varying goals is ultimately what’s brought about a robust GP-led market.
We believe the secondaries market’s wiring for creativity is a strong foundation for its continued growth and the expansion of its footprint into areas such as private credit. With the dramatic rise in sponsor-led direct lending since the global financial crisis, a private credit secondaries market is already taking root. While it’s not registering in the transaction stats relative to private equity GP-led or LP-led transactions, it can be seen in the innovative credit portfolio deals taking place across credit platforms, business development companies, and financial institutions. Just as secondaries have converged with mergers and acquisitions, so too will secondaries converge with other categories of investments. We expect that we’ll see secondaries move into structured credit (collateralized loan obligations and collateralized fund obligations), asset management (GP stakes), and perhaps public equity (special purpose acquisition companies).
Most important, we expect to see secondaries—this formerly unloved orphan of the private equity markets—evolve into the belle of the asset management ball. As we’d expect from a market characterized by innovation and creativity, we see more exciting opportunities ahead for secondaries investors.
1 Evercore, January 2021. 2 Manulife Investment Management as at June 30, 2021. Gross MOIC and IRR ranges are based on the subjective views of the authors and subject to change.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other pre-existing political, social and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.
The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.
This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management or its affiliates. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.
Manulife Investment Management
Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than a century of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams—along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.
This material has not been reviewed by, is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at manulifeim.com/institutional
Australia: Hancock Natural Resource Group Australasia Pty Limited., Manulife Investment Management (Hong Kong) Limited. Brazil: Hancock Asset Management Brasil Ltda. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area Manulife Investment Management (Ireland) Ltd. which is authorised and regulated by the Central Bank of Ireland Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Investment Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad 200801033087 (834424-U) Philippines: Manulife Investment Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G) South Korea: Manulife Investment Management (Hong Kong) Limited. Switzerland: Manuli