LP interview: The secondaries saga

unquote": Paul Capital has been in the secondaries market for over 20 years, how has the market changed in that time?

Elaine Small: The private equity secondary market has changed markedly since its inception two decades ago. During the first decade, the market was dominated by distressed sellers who needed to offload these illiquid assets quickly and discretely. During the past decade, however, two new factors have driven asset sales. The first is regulation, with banks and insurance companies divesting of assets to meet the requirements of Basel III, Solvency II and the impending Volcker Rule. Second, LPs in private equity funds are increasingly using the secondary market as a portfolio management tool.

In these instances, LPs are often simply looking to sell assets to adjust their asset allocations, or perhaps they are acting to consolidate their GP relationships and focus on fewer funds. Portfolio management will continue to drive the secondary market long after the banks and insurance companies have sold off their non-core assets.

As the market has matured, it has also become more efficient, affording an opportunity to new market entrants and intermediaries. However, the barrier-to-entry remains high, given the necessity of an in-depth database to conduct diligence for the assets for sale.

How is the market performing so far this year and how will it develop in the coming months?

ES: The first quarter of 2013 has been quiet. While the reason for this is unclear, one might conjecture that as the public markets have improved, sellers may be more conscious of market timing to achieve optimal pricing. In addition, generally there do not appear to be near-term liquidity issues among most potential sellers. Finally, some of this inertia is seasonal as portfolio managers take stock of their portfolios in the first quarter. Our Q1 dealflow has tended to focus on smaller mid-market portfolios as well as older vintage venture capital assets and some hedge fund portfolios. We expect volume to pick up during Q2 and we are already beginning to see evidence of this.

How do GPs react to the secondaries market today? In the past they have been hostile.

ES: I think familiarity with the market has softened the stance of GPs. Also, GPs generally have come to understand the role the secondary market plays in facilitating portfolio management for their LPs. In addition, increasingly GPs are approaching the secondary market as sellers themselves, sometimes of legacy assets in older funds but, other times, to provide them an opportunity to restructure their funds. This latter type of asset sale is what is often undertaken by the "Zombie" funds you have probably been reading about. So, as the market has matured, it has become a beneficial tool as a liquidity option to GPs as well as to LPs.

What sort of investments is Paul Capital looking to make at the moment?

ES: Our strategy is largely relationship driven and can be summed up by two types of transactions. The first is smaller, mid-market portfolios which are mainly bilateral and where we feel we can provide a bespoke solution. The second area of focus is on large financial institutions, which often require a structured solution to meet the seller's objectives. In these instances, we often syndicate our transactions with our own LPs, which provides our LPs a co-investment opportunity. In all cases, we are opportunistic and solution oriented. As such, we are agnostic as to sector and geography. In fact, we have a thriving emerging markets business, which distinguishes us from our competitors.

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