LPs worry about alignment issues in GP-led secondaries – survey

Half of LPs in Asia Pacific – as well as two thirds of their counterparts in North America and nearly three quarters in Europe – have direct experience of GP-led secondaries, the latest instalment of Coller Capital's twice-yearly private equity barometer survey found. Meanwhile, more than four out of five respondents cited alignment between counterparties as their biggest concern.

"It's a three-party negotiation involving the LP, GP and secondaries buyer. Sometimes the LP may ask where is the alignment and what is really happening? Are we gaining something? Are we losing something? LPs tend to be passive and, given there are three parties involved, it is harder to make a clear decision unless you dig into situations," said Peter Kim, a Hong Kong-based partner with Coller.

Stapled secondaries are a case in point. Numerous GP-led transactions in recent years have essentially been motivated by the need to raise primary capital, with secondary investors taking out positions in existing funds and committing fresh capital to new vehicles. The amount of primary capital available depends on the size of the secondary piece tendered. The risk is that a GP will encourage LPs to sell, its desire to raise money trumping its adherence to fiduciary responsibilities.

This concern is entwined with another that was identified by nearly three quarters of survey participants: a lack of information on which to make informed decisions. When a GP-led situation arises, a tender offer is usually put to all LPs in a fund and they have a certain number of days to respond. If there are misgivings about the motivations of counterparties, can LPs lay them to rest with thorough due diligence?

"It is very difficult for LPs to make a 100% informed decision on whether the pricing expectations are good and whether they want to trade or hold," said Kim. "Typically, they invest in a private equity fund because they want to hold until maturity, unless for some reason they decide to sell. But in these instances, they are not initiating the process, they are getting an inbound offer and they must react quickly. That leads to a lack of being fully informed."

Almost half of respondents said they struggle to meet the timelines set in these deals, with a similar proportion complaining that they have insufficient resources to process the additional workload.

Nevertheless, the wave of GP-led secondaries is expected to continue, even though first-quarter dealflow in Asia was muted as volatility in the final months of 2018 led to uncertainty over valuations. Transaction volume in the region reached $7.8bn last year, up from $2.7bn in 2017, according to Lazard. Over the same period, global activity rose from $16bn to $22bn.

Longer holding periods for private assets and the overhang of unrealised positions are both contributing factors. Kim observed that the secondaries market emerged as a result of LPs needing liquidity in their portfolios. Now it is moving to the stage where GPs are also under pressure to generate liquidity.

The survey found that investor appetite for alternatives continues unabated. More than half of LPs expect to have more than 20% of their total assets allocated to alternatives strategies in 10 years' time, while 43% predict that the private equity share will be above 10%. At present, only one-third exceed the 10% mark. This bullishness is accompanied by a recognition that returns are moderating. Only one in five respondents said their PE portfolios had delivered net annual returns of 16% or more since inception. This compares to just under half in 2007. Two thirds said they are now getting 11-15%.

Improving employee diversity is a goal for GPs and LPs alike as they look to improve their internal environment, social and governance (ESG) performance. Flexible working hours and environmental impact are also priorities for nearly two thirds of LPs, while GPs are spending most time on employee ESG training and charity commitments as well as environmental impact.

As for the implementation of ESG programmes across portfolios, the survey identified growing unease among LPs about how ESG is defined. "As an industry, we need to be very conscious of ESG and implementing ESG policies, rather than leaving it very vague where it's just a case of ticking the ESG box," Kim said. "GPs are becoming more aware of ESG, but even in Asia, we see some GPs that could do more when they make investment decisions and post-investment."

This article was originally published in Unquote sister publication AVCJ

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• Topics
• LPs
• Secondaries
• Secondaries
• Coller Capital