Secondaries in Asia: Small beginnings

Although secondary investments have been present in Asia for some years - with the more mature markets of Australia and Japan leading the way - the major protagonists were mid-market firms. They were engaged in a combination of traditional (buying LP interests in funds) and direct (engaging with GPs directly on asset or fund restructuring) secondary investments. Global players such as Coller Capital, HarbourVest, Lexington and Greenpark Capital found deals but ticket sizes were small and the flow was inconsistent. This began to change in the last year or so.

"I am here to establish the secondary capability in the region primarily to get into the increasing deal flow we're seeing," Flower told AVCJ on his arrival. "It's a natural evolution of the market."

The guarded optimism came in stark contrast to the headline secondary deals being struck in the US and Europe. As banks adjust their risk exposure to comply with the Volcker Rule, which limits investments made with their own capital, as well as increased capital requirements that come with Basel III, there has been a string of high-profile divestments.

Secondary market deal volume came to $21 billion last year and it tipped to reach $25 billion this year. Calculations by Lexington in 2008 found that the leading banks had $100 billion in alternative investments on their books. According to other figures seen by AVCJ, Bank of America, JPMorgan, Citi, Wells Fargo, Goldman Sachs and Morgan Stanley have $622 billion in tier-one capital between them. The Volcker Rule dictates that no more than 3% of this capital can be put toward alternative investments.

By comparison, Alex Lee, investment director and head of secondary investments at AxiomAsia, estimates that there was just $3 billion in secondary commitments in Asia last year - the same as in 2009 - and only $1 billion of that was fully deployed.

As one Asia-based fund-of-funds LP put it: "All these secondaries firms are coming to Asia, but what are they going to do here?"

Making friends

The short answer is they aren't going to be chasing many large deals. Rather, these firms are laying the ground for future investments and forging strong relations with regional investors. "We are not making a substantial percentage of business over there - we view it as a growth opportunity," Brent Nicklas, Lexington's managing director, tells AVCJ. "Right now the Asia office is a liaison office to many investors in that part of the world. We also liaise with GPs in the region and put capital with them in small amounts. We will handle secondary deal flow when it arises."

He estimates that no more than 15-20% of the firm's recently raised $7 billion fund will be deployed in Asia-related assets. If the 20% - or $1.4 billion - level is reached, the value of Lexington's business in the region would more than double. Secondary investments account for $17.8 billion of the company's overall $20 billion in funds under management, but only about 3% of this - $600,000 - is in the Asia-Pacific region.

The importance of liaising with investors cannot be ignored. Plenty of investors in the region - notably sovereign wealth funds - are keen to participate in secondary funds. And in some cases, their participation is expected to stimulate deal flow.

It has been widely reported that China Investment Corp. is one of two investors that contributed $500 million to Lexington's $7 billion vehicle and in return were granted separate accounts within the fund. Nicklas - although unable to confirm the identities of the account holders - explains in the Q&A on page 11 how the arrangement came about, stressing that it is in the best interests of the other investors: these two organizations are the first port of call for many LPs looking to exit a position.

In much the same way, deals tend to reach secondary investors because people know they are looking. Large portfolios of assets - such as those being offloaded by banks and pension funds - are often sold via auction. But for those firms that also operate co-investment vehicles or fund-of-funds that take positions in GPs, secondary opportunities are passed easily through the grapevine.

"A lot of single-fund interests are originated through GPs who are looking to build stronger relationships with providers of primary capital," says HarbourVest's Flower. "Our fund-of-funds team may be conducting a due diligence meeting or update meeting with a GP in, for example, Mumbai when they'll say, ‘We have an investor looking to sell an interest in Fund IV, are you interested?'"

Portfolio management

For many institutional US LPs, exiting a fund via the secondary market has become a standard part of portfolio management - the board decides to reduce its exposure in one area in order to boost it in another. There are some exceptional situations. CalPERS' announcement in February that it would sell $800 million in private equity fund positions was part of a strategic decision taken in 2010 to take larger stakes in fewer funds. Meanwhile, a number of US endowments were forced to sell off assets after the global financial crisis, having overcommitted to the asset class in the expectation that distributions would fund capital calls.

The bank divestments represent another exceptional situation, although secondary investors say that these deals account for a relatively small proportion of the overall total.

In addition, a GP might facilitate the exit of an investor in one of its funds, particularly if it is looking to raise a new vehicle and wants existing LPs to swap out their current commitments in order to create liquidity for new ones. GPs have also been known to seek fresh capital in a bit to prolong the life of a fund and extract more value from the assets, some of which might be unrealized. In these cases, the secondary investor is essentially providing growth capital.

"Dealing with GPs directly has evolved very quickly," says Jason Sambanju, managing director of secondary investments at Paul Capital. "It's interesting how many people approach you. You used to be able to raise a fund in two years and support the existing fund with the next fund, but people are becoming more focused in the way they allocate capital."

The big question is how many of these LP portfolios on the global secondary market are relevant to Asia. According to a Preqin, real estate fund positions are the most likely to be put up for sale. As to the region, 71% of potential sellers expressed an interest in exiting European-focused funds, with North America and the rest of the world (dominated by Asia) on 48% and 34%, respectively.

Lee says that pan-Asian buyout funds account for about half of his company's secondary deal flow, simply because these vehicles tend to have raised the most capital. The rest is a mix of country funds, particularly those raised in 2006-2008. HarbourVest's Flower also highlights pan-Asian funds as well as Asian private equity portfolios held by international financial institutions.

Japan and Australia, where private equity has the longest history, traditionally offer the most potential. In Japan, opportunities can be difficult to realize, but the Cooper Review into Australia's superannuation funds has created openings. The Review advocates greater transparency regarding the fees charged to investors, and many expect now fees are therefore likely to fall. Funds are also likely to reduce private equity exposure.

An evolving market

Ultimately, the secondary market reflects fundraising trends in the primary market. As such, there is no need for secondary investors to be first movers in a region. The industry first gained traction in the US in the 1990s, roughly 10 years after the primary private equity business had taken root and demand grew among investors for more exit opportunities. Europe was a further decade behind - Lexington opened its London office in 2010 - and now Asia is following suit.

Given that fundraising in the region didn't really take off - or at least reach levels that would be attractive to global secondary investors - until 2005, many vehicles are still in their early stages. This, combined with the healthy returns (in some cases, still only on paper) that many funds have secured on the back of strong regional economic growth, means that LPs are in no rush to unload Asian portfolios.

"Buying old investment funds and mature portfolios is very much an opportunity for today and tomorrow," says Flower.

Paul Capital's Sambanju describes a secondary market that is far more fragmented than its more established Western brethren - again, a reflection of the primary investment environment. While traditional deals, the purchase of assets from LPs, accounts for roughly three-quarters of the global market, in Asia these numbers are more opaque. Far more time is spent dealing with GPs directly, and the assets within their portfolios, which in turn must be traced back to LP level.

It creates more openings for co-investment with GPs as well as spinouts from existing GPs, but at the same time, deal sizes are smaller. Paul Capital typically pursues transactions in the $20-100 million region and Sambanju is unsure about the volume of deals worth $75 million-plus, which is what the large-cap funds go after. But, he adds, this is an assessment of the market as it is now, not what it might be. As portfolio positions in the region get bigger, this means more opportunities for secondary specialists.

"Growth in the secondary market is going to continue because the primary market itself is growing," adds Axiom Asia's Lee. "There is always going to be activity in the secondary market because a secondary transaction is the only way an investor can exit from a typical private equity fund before the end of the fund's life."

 

Who's selling?

AXA Private Equity has raised $3 billion for its fifth secondary fund, according to reports in August. In the last 18 months, it has bought more than $5 billion in private equity portfolios from banks, including Barclays, Citi and Bank of America Merrill Lynch (BofAML). Lexington Partners also been active, spending more than $1.9 billion last year on portfolios put up for sale by Lloyds and BofAML and teaming up with StepStone to purchase of $1.1 billion in private equity assets from Citigroup.

For all the fuss around bank divestments, it would be wrong to conclude that such deals are pumping up the secondary market to untold heights.

"These institutions will continue to be an important source of deal flow, but 60-70% of what we look at comes from other sources," says Tim Flower, a vice president at HarbourVest. "Is there a one-off glut of deal flow coming down the pipe? All I can say is that we've never struggled to find interesting deals."

Brent Nicklas, Lexington's managing director, adds that fiduciaries like pension funds account for the bulk of the $1.6 trillion in global private equity inventory. He asserts that these fiduciaries reassessing their private equity exposure on a year-to-year basis and putting various portfolios up for sale will remain the industry's lifeblood.

 

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• Topics
• Secondaries
• Secondaries
• South Asia
• North Asia
• Greater China
• Australasia
• Southeast Asia
• Investments
• Lexington Partners
• HarbourVest Partners
• Coller Capital
• Paul Capital Partners
• Greenpark Capital
• Axiom Asia Private Capital