Secondaries: The personal edge

When HarbourVest Partners reached a final close of $4.8 billion on its latest global secondaries fund earlier this month, it fed expectations that a record year of fundraising could precipitate an outpouring of capital from GPs under pressure to deploy. That imbalance between buyers and sellers in this scenario could be especially acute in Asia, where the combination of strong fundamentals and a rising number of funds seeking end-of-life solutions has stoked huge interest in the direct secondaries market.

The fund was launched in September 2015 in the wake of a particularly rocky summer for Chinese equity markets that inspired a small wave of deals. As this activity has tapered off, however, intense competition means that relationship-building has arguably never been more important. Secondaries specialists will be judged on their ability to identify proprietary deals, price the assets and assess the manager quickly and effectively, and then close.

"You need time not just with the assets but really to get to know a GP if you've not already invested with them - understanding what they've done historically and where they're going," says Tim Flower, a managing director with HarbourVest in Hong Kong. "That's not something you can run in a six-week process. You need 3-6 months to do that. That's where we spend our time, to get under the skin of why that GP is in that situation."

Good groundwork

In Asia, attaining preferred buyer status among GPs is often a matter of being able to navigate sensibilities around a lack of familiarity with secondaries processes through extensive personal contact in a firm's offices and advisory committees. The critical consideration in relationship building is bringing strategic value to the targeted GP - and for those with primary capital as well, it frequently means offering the possibility of LP commitments to future funds.

While momentum among GPs to pursue more specialized strategies by reshuffling portfolios could contribute to an uptick in secondary transactions, recent volatility in Western markets - exemplified by the UK vote to leave the EU and the US presidential election - represents an uncertainty variable that extends to Asia. This environment has obliged secondary investors to leverage not only an intimate knowledge of GPs but an entire database of continuously updated information on regional risk factors and opportunities.

"You have to know these Asian markets to be able to pick the good assets in times of volatility," says Lucian Wu, managing director at HQ Capital. "Do you know the GP well enough to say whether the fund has conservative or aggressive valuation policy? By the time you get to a deal where you are asked to price an asset, it's already too late to build a relationship, so we do it on an ongoing basis."

Establishing relationships, however, could be seen to be at odds with direct secondary strategies targeting end-of-life deals since the management teams involved may see members leave or be replaced completely. Although these situations presents difficulties in evaluating seller motives and valuations, they can present opportunities for greater deal flow and willingness to transact at a discount.

ICG, for example, sees potential in the stakeholder frustrations associated with senior team turnover. "It's caused a lot of angst in the old LP base because they underwrote a situation years ago with specific partners and key men in place - and that's all changed," says Christophe Browne, co-manager of the firm's strategic secondaries business, which focuses on GP restructuring transactions. "It's a big driver of a motivated seller in the LP base and that's why we think the way to approach these deals is to be very asset focused."

The biggest concern among secondary investors around asset-focused, end-of-life deals is the notion of picking up the same problem that the current GP has - attaining strong value on the deal but with a slim path to liquidity. This issue often cuts deeper in Asia, where exiting complications are anecdotally held up as indirectly hampering deal flow.

"[Our] lens is very much on the GPs that we hold in higher regard versus the more end-of-life situations where the firms are struggling to raise new funds, because those assets in there are probably trapped for a reason," says Troy Barnett, a partner at Adams Street Partners, noting the liquidity issues tied to the regulation of China's IPO market. "That does price its way into the market for sure, and likely won't go away until you find a true registration-based system or a system that is more predictable overall."

The LP angle

Strategies for realizing direct secondaries in regions with low confidence in exits can also be enhanced by improving LP relations. Buyer tendencies to push out the timeframe on assets with questionable liquidity options often translate into deal-breaking discounts for LPs that could be defused by anticipatory negotiations. Understanding the LP perspective can likewise facilitate transaction structures for assets facing exit obstacles whereby investors effectively offer a replacement of the standard one-year extension process in the form of a 4-5 year extension that gives sellers an option to cash out.

Depth of relationships and knowledge about industry players can also play a disproportionately large role in the Asian secondaries market due to cultural challenges related to the region's relative immaturity. Given that it is generally harder to obtain good information in Asia, a familiarity with the target GP translates into that all-important speed advantage over competing bidders.

"In my experience, it's easier in Asia for a knowledgeable LP who knows the GP universe well to obtain information because GPs are less sensitive sharing information with people who could potentially support their future funds," adds HQ's Wu. "It is important to have an information advantage when you are a secondary buyer - but that situation is somewhat magnified in Asia because there is still inefficiency and opaqueness. This helps us find value because not everybody is able to access certain information."

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• Topics
• Secondaries
• Asia
• Secondaries
• HarbourVest Partners
• HQ Capital
• Intermediate Capital Asia Pacific
• Adams Street Partners