Secondaries show Asia’s maturity?

Secondary trading of positions in Asia Pacific funds, the argument goes, should pick up from its presently low levels once the primary fund base has grown enough – and LPs have been in the region long enough. So the surge of secondary inventory that hit the global market post the GFC, and the related raising of secondary funds, sparked extra interest among Asian market participants, who were interested to see how far the region would become involved. Yet anticipated deal flow failed to match expectations. Now, with market norms recovering, and primary fundraising resuming only slowly, activity is reviving in secondaries, but with mixed results for hopeful investors in the sub-asset class.

The crisis and the shakeout in funds

Most LPs who committed funds to secondary vehicles or sought to become buyers of assets earlier last year wanted to capitalize on the very visible upheavals in the asset class. Jason Gull, Partner with Adams Street Partners, regards this approach as essentially incorrect.

“LPs have viewed secondaries as a flavor-of-the-month opportunity to take advantage of market dislocations,” he observes. “The problem is that there is around $47 billion of capital available by dedicated secondary groups.” Add to this the opportunistic occasional investors in the secondary space and, he concludes, “supply and demand is significantly out of balance.”

Some $60-70 billion of secondary positions were offered on a gross basis during 2009, according to figures from Stephan Schaeli, Partner and Head of Private Equity at Partners Group, However, he adds, “it’s true that in 2009, not so much cleared; we estimate $10 billion.”

As Lucian Wu, MD and Head of Asia at Paul Capital, admits, “2009 has been a slower year than a lot of people had expected.” That sentiment is echoed by Alex Sao-Wei Lee, Investment Director and Head of Secondary Investments at fund-of-funds Axiom Asia. “The tsunami of secondary transactions that many LPs expected did not materialize in 2009, and pricing has since increased.”

This dearth of transactions actually reflects better-than-expected private equity performance through 2009. “The amount of capital that was actually called by GPs, both in this part of the world and in developed markets, has been slower than people expected,” notes Wu. “On the distribution side the returns out of portfolios have been better than expected.” All this means, though, that the theoretical discount levels of up to 80% quoted in the market in 2008-09 remain unfulfilled promises.

However, volumes are definitely recovering in 2010, even if at higher-than-expected prices. “After a significant drop in deal volume in 2009, secondary investment activity has ramped up significantly,” notes Jeff Keay, Principal at HarbourVest, adding that, according to his estimates, “secondary deal volume for the industry in the first half of 2010 already exceeds the total for all of 2009.” Some have found the pickup especially sharp. “In January, transactable deal flow, of good quality and reasonable pricing, came to the market in big volumes,” says Matthew Arkinstall, Investment Director at Greenpark Capital.

The pricing dilemma

The question of pricing was fundamental to the stalled market in 2009, as the huge inventory of positions already remarked on drove down pricing power of sellers. Greater market certainty in 2010 has delivered better mutual understanding on valuations, and allowed some deals to close. “We have started to see transactions clearing in the market,” avers Lee. Pricing, he adds, remains capricious. “Discounts have narrowed but there’s still a wide range depending on the fund in question.” He sees ranges from no discount at all to 40% of NAV.

During the worst of the GFC, the secondary deals that did happen were essentially fire sales. “In 2009, motivated sellers transacted irrespective of pricing,” notes Arkinstall, who saw about 50% of sellers “motivated by the absolute need for cash, well up on what this percentage has been in prior years.”

The drivers for transactions now happening in the market are probably less likely to provide bargain opportunities for hopeful institutional investors. Current sales are mostly being driven by active portfolio management and moves to optimize an LP’s number of GP relationships, believes Gull. They are discretionary; not essential. “Thus, sellers are extremely price-sensitive.”

At least 2010 appears to have seen the end of the experimental offering of portfolios by uncommitted sellers. “With some stabilization in the market, and a real possibility of a double dip, we see some sellers coming out,” remarks Wu. And Keay confirms that, “many of the sellers today are institutions who tested the market last year but chose to wait.”

However, Gull adds, with LPs worldwide very sensitive to overall returns and recent losses, “market pricing today of transactions that are closing – a very important qualifier – is in the 85-100% of NAV range. Bids continue to occur for certain funds at lower ranges, but don’t receive much consideration.”

Secondaries’ true value – in Asia and elsewhere

The market has also seen a shift in the dynamics driving secondary purchases, reflecting the purposes they fulfill. For the buyers, in Asia as elsewhere, secondary investments are often strategic moves intended to build relationships with new firms, to expand overall exposure to the asset class, or even to learn more about it, as much as pure value-driven transactions. Many new entrants to the asset class sought to use 2008-09 dislocations to build their programs. “Secondaries are still a good way to build relationships with new funds,” Schaeli feels. And Wu confirms that, “top-down, Asia-based LPs are to some extent looking to build a portfolio, rather than looking for portfolio management.”

However, many potential LP buyers in Asia are still coming to understand secondaries, which has retarded the growth of the local market.” Growth of the secondaries market is driven mainly by LP awareness,” explains Arkinstall, citing years spent “explaining secondaries to LPs who had never heard of them before.” Awareness in the region, he says, “is still growing.”

For those who do understand them, however, the right kind of secondaries can be matched neatly to LP needs. Schaeli outlines the advantages of so-called young or early secondaries, typically 0-30% funded positions, for institutional investors like Asia LPs who are just coming to the asset class.  “Those types of transactions are quite a good fit for new types of investors, pension funds or institutions who like to build up portfolios, where you focus mostly on the quality of the GP you buy into, and the portfolio is not so meaningful.”

Wu also sees chances for Asian institutions, through secondaries, to gain exposure to a variety of vintages, some of which may predate their own private equity programs. “It is a very good opportunity to look back into the years, to get access to the funds that have been raised in the past, almost instantaneously.”

Asia’s place in the secondary ecosystem

Asia remains still very much an emerging private equity secondaries market, even more than the primary market. Opinions differ on how significant the initial activity is. “In the past two years  there have been a lot of credible Asian funds that have been raised,” and have found themselves in the portfolios of international investors, observes Schaeli.  Gull remarks, “very few trades have taken place, and there is very little deal flow.” Schaeli concedes that Asia Pacific secondary deal flow is probably still a single-digit percentage of global volume.

Problems in analyzing or pricing Asian assets could be one factor. “It’s a different market, because there’s not one Asia; it’s several sub-markets,” admits Schaeli. “You need to be very close to those assets.” And the successful Asian private equity secondaries franchises confirm that they remain a small group. “We have been one of the few secondary managers who have succeeded in doing a significant number of Asian secondaries,” notes Tycho Sneyers, Partner at LGT Capital Partners.

Lee also sees activity levels as limited, with “Asia still at an early stage of development relative to the US and Europe,” and what trades there are originating from sellers outside the region. The market recovery during 2010 has made little difference to this picture so far, he adds. “In the first half of this year, the majority of potential sellers were US-based, and many were financial institutions based outside Asia.”

If anything, the current interest in Asia is cooling the market. “The interest of buyers is clearly there, but it’s also fair to say that many sellers, even those who need to sell, are still building up Asia, and therefore would sell more US or European assets first,” confirms Schaeli.

Prospects for a better Asian secondary space

New Asian investors, meanwhile, whether SWFs or independent LPs, may need to mature their capabilities more before being able to realize full value on secondaries. “Those new buyers, as we have observed, are not as equipped or set up to value diversified portfolios,” remarks Schaeli. “A certain specialization is necessary, and a critical mass of valuation teams.”

Keay sees other structural reasons among the region’s LPs for the slow deal flow to date, citing “the smaller population of Asian institutions in need of liquidity that also have diverse and mature private equity portfolios of scale.” And Arkinstall emphasizes the need for personal contact to promote the secondaries story to Asian LPs. “Spreading awareness of secondaries is more about individual relationships.”

The established value of secondaries to LPs is likely to be more appreciated by Asian institutions in time. “LPs continue to view an allocation to secondaries as a valuable tool for taking advantage of the distress, regulatory pressure, and liquidity needs that continue to exist for many institutions,” avers Keay.

“As a first mover in this sector in Asia, it’s a bit of a virtuous cycle,” Wu concludes. 

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Secondaries
• LPs
• Fundraising
• Funds
• Performance
• Advisory
• LGT Capital Partners
• Tycho Sneyers
• Paul Capital Partners
• Lucian Wu
• Partners Group
• Stephan Schali
• Axiom Asia Private Capital
• HarbourVest Partners
• Adams Street Partners
• Jeffrey R. Keay