Q&A: Lexington Partners' Brent Nicklas

Q: What are you expectations for global secondary volume?

A: We have been projecting an average of $25 billion per year, or more than $100 billion in total volume over the next 4-5 years. This doesn't include direct secondary transactions, which are running at $2-3 billion a year, so you could add $10 billion to the four-year number.

Q: How come 2013 has so far been slower than 2012?

A: The final regulations for the Dodd-Frank Act and the Volcker Rule were being written in the first half of this year, so banks were waiting to see how they came out. The rules are actually tighter than people had anticipated. All major banks doing business in the US must file an extension request by January for assets they don't anticipate being able to sell by mid-2014 and if there is no filing they have to complete the liquidation process by July 2014. You might have a really big 2014 as banks begin to dispose of their PE assets. Since the global financial crisis, major banks and other financial institutions have sold about $40 billion of PE. We estimate they still hold more than $100 billion and if only half of that is sold in 2014 to comply with Volcker, there is at least another $50 billion to go.

Q: What does this mean for Lexington?

A: Lexington VII was $7.1 billion and it's now 95% committed so we have been putting out $2-3 billion a year for the last three years. We are ahead of schedule because the investment period doesn't end until next year. We have always said that, given the size of the secondary opportunity post-global financial crisis and the trends towards more active portfolio management among the pension funds, it would take two funds to work off the imbalances.

Q: How prominently has Asia featured in Fund VII?

A: We have seen more secondaries opportunities out of Asia than we would have expected. Investors in Asia like private equity, in part because they don't necessarily have deep public markets, but they dislike illiquidity. The turnover rates, even though inventory is still growing, will be higher than in other parts of the world. Lexington could purchase up to $200 million a year in Asian funds. I think we've seen volumes in excess of that already.

Q: What will be the impact of consolidation in the secondaries space?

A: We divide our competitors into two groups: independent firms and then captive or public firms. Ten years ago it was almost all independents. Now it's less than half, because a lot of the new entrants and some of the independents have chosen to affiliate. When it comes to financial institutions selling PE assets, large financial buying platforms can be difficult from an alignment and competitive perspective. For example, a bank or insurance company might not want to sell to a competitor. Even more complicated, several large public PE firms have acquired secondary platforms without the ability to make large primary commitments. They also compete with some of the large sponsor funds being offered in the secondary market.

Q: Lexington has never felt the need to do this...

A: We have made more than 200 primary investments over the last 10 years, putting out $1.5 billion. We do it strategically within the secondary funds. We don't want to be big in the primary business because it is inherently a difficult area, well-served by the major FOF managers. If you look at it as a barbell, most people have used the bar - fund-of-funds and primaries - to then diversify into the alpha products, which are secondaries and co-investments. I would rather own the barbells than the bar. The bar is getting shorter and people want to add more weight to the barbells because it's proven that secondaries give you, through the discount and j-curve jumping, an enhanced yield and with co-invest, you bring down your average cost of management fees.

Q: In private equity generally, are the big just getting bigger?

A: You have the big five - Blackstone, KKR, Carlyle, Apollo and TPG - and then Oaktree in distressed debt. It's going to be difficult to challenge these firms, given the requirements in terms of regulation, compliance and global presence. They have thousands of people, billions of dollars of capital and access to the public equity and credit markets. It is somewhat similar in secondaries in that only a few firms that can handle a $1 billion deal. When you combine the size of funds with the quality and size of our LPs, we are often the preferred buyers. You don't get that at the lower level so there is a lot of power in terms of our ability to lead large deals and syndicate when appropriate.

Q: There is now also a sub-set of very large LPs. What do they want from you?

A: They want us to be there in the big deals. They like being part of that process and also looking at secondary co-investments. If you are a sovereign wealth fund or large public pension and we are helping de-risk a major corporate pension fund, or releasing tier-one capital for a global bank, they like that stuff. Rather than syndicate that excess opportunity to our competitors, we want it to flow to our LPs.

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