Secondaries: The direct approach

The fallout from the global financial crisis and the pressure that has been placed on banks to limit investments made with their own capital has left captive funds in a bind. Although some fund managers have received their bank's backing to continue PE investments, others recognize that their activities will be constrained.

"The captive GPs within these banks question whether there is a long-term sustainable platform they can build a career on," says Jason Sambanju, managing director for secondary investments at Paul Capital. "They may not see new investment capital allocations and no investment professional is really in the business not to do deals."

Spinouts alert

LPs in Asia, including secondary investors, are on the lookout for potential GP spinouts from investment banks. There have been two so far. In December of last year, the senior executives of HSBC Private Equity Asia separated from its parent and formed Headland Capital Partners. The 16-strong investment team went with them but the assets remain on HSBC's books. Headland is responsible for managing the existing portfolio and HSBC will invest in its new funds.

Barely six months later, Bank of America Merrill Lynch's private equity business spun out as NewQuest Capital Partners. In this case, part of the existing portfolio left as well, with Paul Capital, HarbourVest Partners, LGT Capital Partners and Axiom Asia backing a $400 million fund to acquire and manage the assets.

It is the first secondary deal of its kind in the region and NewQuest has an equally groundbreaking investment mandate: It focuses on direct secondary investments - buying portfolio companies and other assets from GPs looking for liquidity.

"I am not aware of any other pan-Asian direct secondary firm currently active in the market," says Alex Lee, investment director and head of secondary investments at Axiom Asia.

NewQuest's reputation is built on its work on Merrill Lynch's private equity business after the global financial crisis. The evolution of the business, as described by industry participants, is common to many investment banks. The captive team had a mandate to do private equity but other departments were also able to put capital to work. Factor in staff turnover - and with it a fair amount of expertise turnover - and banks emerged with diversified asset pools that would seem alien to an independent fund manager operating under a specific investment remit.

A portfolio of over 20 of these private equity positions was purchased from the bank by Darren Massara, now managing partner at NewQuest, and his team. The firm has a number of portfolio acquisition transactions in the pipeline and hopes to return a significant amount of capital to investors in 2012.

"To be able to pull that altogether, lead a syndicate, conduct due diligence, negotiate the terms with the bank and with the team, and manage the transfers - it's a very complicated process," says Sambanju. "Each investment might include special rights for other stakeholders."

Massara is targeting direct secondary investments due to a perceived imbalance in the primary market. According to his calculations, there are about 2,500 genuine private equity investors in Asia - funds, hedge funds, family offices, corporates and banks - and 2,000 deals a year.

"More and more investors are chasing so few transactions on the primary side," Massara says. "You see companies who are raising primary capital getting over 20-25 term sheets for any given financing round. It's difficult for GPs on the primary side to deliver value to their LPs with such a competitive environment."

He estimates that only 10% of exits in Asia are executed through a secondary sale to another private equity firm, compared to about 50% in Europe and 30% in the US. With IPO and trade sales exits being so unpredictable, there should be opportunities for direct secondary specialists to move in when traditional exit windows are missed. GPs also look to sell off assets in order to boost their exit track records ahead of new fundraising efforts or if a fund is being shut down.

Needing liquidity

The low-hanging fruit is typically opportunistic investors - hedge funds and family offices that got into private equity in the boom years of 2006 and 2007 with a 3-4 year investment horizon and are now looking to get out. Beyond that, the bulk of the opportunities may lie a few years down the line when the bulk of the current generation of Asian funds begins to wind down.

"Many of the GPs in Asia raised the bulk of their money in 2004-2006 so the funds they manage would need to liquidate in 2015-2017," Massara says. "Over the next 2-4 years, most direct secondary opportunities will come from investors seeking to reduce their PE exposure in Asia. After 2015, monetizations by existing GPs should become more prevalent."

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• Topics
• Secondaries
• Investments
• Paul Capital Partners
• Axiom Asia Private Capital
• LGT Capital Partners
• HarbourVest Partners
• Headland Capital Partners
• NewQuest Capital Partners