Fund focus: Lexington targets growing Asia secondaries market

Lexington Partners has made its presence felt in Asia over the past couple of years by taking the lead in the region's two largest GP-led secondary transactions. Deals of this nature – often involving brand-name private equity firms – have emerged as a significant growth driver of secondaries globally. According to investment bank Greenhill, aggregate GP-led secondaries value hit $24bn in 2018, up from $14bn the previous year. It reached $14bn in the first six months of 2019 alone.

Nevertheless, Wilson Warren, president of Lexington Partners, is wary of becoming too bullish on the trend. The specialist secondaries investor has dry powder aplenty, having recently closed its ninth flagship fund on $14bn, but it is unclear how prominently GP-led deals will feature. "It's a bit episodic. The percentages can be different every year because these transactions are lumpy," Warren says. "There is an interest in that percentage increasing, but it's dependent on a lot of factors. One of the factors is: can buyers offer a liquidity alternative to holders of these assets that clear the market?"

Presenting an attractive alternative usually means offering a financial incentive. When these deals are used to reshape an LP base or finish off a fundraise – ie not when a troubled manager is struggling to get initial traction – they are often priced close to the net asset value (NAV) of the target portfolio. In some instances, they have been priced at a premium. If investors started making discounted bids, LPs might well decide it is in their interests to persevere rather than trade.

"We are receiving more inbound inquiries and that will continue to be the case," says Kirk Beaton, a partner and head of Asia at Lexington, "but our bar is very high. We have turned down multiple deals. You must get the right price for sellers to come to market and each deal is different. Even if it's a high-quality GP, a transaction might not work for Lexington. The Warburg Pincus deal was an interesting one for the market because they are a blue-chip GP and it enabled us to have conversations with other groups that hadn't really thought about that type of transaction in Asia."

Accessing Asia
In late 2017, Lexington teamed up with Goldman Sachs to acquire a $1.2bn strip from Warburg Pincus's 11th global fund, comprising a minority stake in every Asian investment. Warburg Pincus – which continues to manage the investments – wanted to right-size the portfolio and lock in some gains. A year earlier, the firm backed Madison India Capital's purchase of positions in about a dozen companies from Sequoia Capital India. It was not a pro rata strip, so the investors had some choice over the assets involved, and it was tiny compared to the Warburg Pincus deal in terms of size and impact.

Lexington returned in 2018 with a more conventional stapled secondary involving TPG Capital's fifth and sixth Asian funds. It made a tender offer to LPs and took out various existing positions, as well as investing new capital in TPG's seventh fund for a total commitment of around $1bn. The pricing was close to the NAV of the blended portfolios and most LPs chose not to tender their stakes.

The point about episodic dealflow is especially pertinent in Asia, which has nothing like the depth of secondaries transaction history in Europe and the US. GP-led transactions worth a combined $4.8bn were completed in 2018 in Asia, up from $2.7bn the previous year, according to asset manager Lazard. However, 2019 was more muted. A handful of investments closed, and nothing to match Warburg Pincus or TPG.

Secondary volume rose globally from $58bn in 2017 to $74bn in 2018 (so the record level of GP-led activity still only accounted for one-third of the overall market) and then $42bn in the first six months of last year. Nine deals of $1bn or more were struck in the first half, collectively amounting to 37% of the global total. They included what has been described as the largest ever secondary transaction: Ardian acquired a $5bn portfolio from Japan's Norinchukin Bank. Earlier in the year, Lexington picked up LP positions worth $1.4bn from the same seller.

Meanwhile, Greenhill estimated that secondaries investors had $169bn at their disposal as of June 2019, comprising $91bn in dry powder, $44bn in near-term fundraising, and $34bn in available leverage.

Lexington's ninth fund is the joint largest ever raised in the secondaries space, with commitments coming from more than 450 investors, ranging from sovereign wealth funds to high-net-worth individuals. The firm beat its $12bn target and comfortably exceeded the $10.1bn raised for Fund VIII, which closed in 2015. The fundraise is seen as a reflection of the secondaries opportunity set within the $3.4tn committed to alternatives in the primary vintage years of 2012-2018.

A diverse market
Lexington has already committed approximately 30% of the corpus across more than 30 transactions, sourced from public and corporate pensions, foundations and endowments, banks, and other financial institutions. The firm's internal estimate is that secondary volume reached a record $85bn in 2019, up from $68bn the previous year. It expects continued growth as LPs engage in active portfolio management, some investors seek earlier liquidity, and sponsors pursue GP-led transactions.

At the same time, these private equity positions have become increasingly complex. "There are a lot of holders of co-investment these days, commitments to funds have gotten larger, there are separately managed accounts out there. The secondary market and the sellers have become more diverse over time. And that's before you even start talking about more organised transactions, what the market is now calling GP-led transactions," says Warren.

Norinchukin's activity in 2019 offers a snapshot of what might be achieved in Asia as large institutional investors undertake portfolio rebalancing. Lexington celebrates its 10th anniversary in the region this year, and the local team now numbers 10. The firm has spent its time cultivating relationships in the anticipation of future dealflow, as well as initiating transactions and bidding for assets. Warren observes that Asian sellers might be quicker to embrace secondary solutions than their Western peers.

"Even though the programmes might be younger, some of the main issues from a portfolio standpoint that US and European holders of these assets have realised over a longer period, some of the Asian investors have figured out early," he says. "They have thought about how many managers they want to have and what to do with non-core as their strategy changes and evolves."

Whether this translates into increased dealflow in the medium term remains to be seen, but Lexington is willing to be patient. The firm looked at $125bn's worth of assets last year and invests at a pace of $3-4bn per annum. "A fair percentage of that $125bn didn't trade, so maybe it's not a transaction for today," says Warren, "but it's a relationship and a discussion we've begun, and could come back to."

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• Lexington Partners
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