Q&A: Coller Capital’s Francois Aguerre

Q: In many markets, deal flow and valuations are at record levels. What does this mean for secondary investors?

A: Volume is going up, and that’s driven by economies growing. When I was young, a large global company would be worth $10 billion; today it is $1 trillion. So, private assets are growing, and valuations are increasing as well, which is potentially more of a cyclical effect. This is happening in North America and Europe, and we see a very similar phenomenon in Asia, although the growth equity and venture capital portion of the market is higher. Growth in secondary market volume is an inevitable consequence of primary market growth.

Q: What have you seen post-COVID-19?

A: Take 2020 out of the picture, and the level we will reach in 2021 – probably close to $100 billion – is a direct continuation of 2018 and 2019. While $100 billion looks like a big number, because 15 years ago it was $10 billion, it’s still a small part of the overall industry. We have projections for $500 billion over the medium term.

Q: GP-led deals account for an increasing share of the overall market. Will this change?

A: The GP-led market is taking over for now. I say “for now” because secondaries are a liquidity solution for participants in illiquid markets. Historically, LPs were getting used to it. Now GPs are using it prolifically. This is partly driven by intermediaries who bring tools to market participants. An intermediary advising on a $1 billion GP-led transaction will charge more in fees than for a transaction involving a traditional LP portfolio of similar size. They are skewing the market towards GPs, but when the market dynamics change, you might see a reverse.

Q: What would lead to a reverse?

A: First, an LP transaction is a different kind of investment to a GP-led transaction – a lower multiple but higher cash velocity, greater diversification – and that leads to different portfolio composition and construction. Second, if intermediaries received the same fee regardless of transaction type, they might not have a preference. Third, some secondary capital is being used to execute single-asset transactions, but most of that capital could come from traditional investors – the sort of people who typically do co-investment. The underwriting in a single-asset continuation deal is not fundamentally different to a co-investment.

Q: Are high valuations a reason for more deal flow, on the LP side or the GP-led side?

A: LPs might say, “The market is high, I want to crystallize some returns and de-risk my investment.” Equally, those LPs continue to invest in the asset class. On the GP side, I don’t think the deals are driven by valuations. The dynamic is straightforward. GPs realize that there is enough acceptance in the market for them to tweak the traditional private equity structure. The concept of holding an investment for five years and then exiting is something that is not natural for an economic cycle; it is driven by the fact that we’ve been working with 10-year funds for a long time. A six-year, 15-year, or evergreen fund has a different cycle. Private equity firms will continue doing GP-led transactions with performing assets for the benefit of all and themselves in particular.

Q: How many times have you seen an asset rolled over?

A: Over the last 20 years, some assets have gone through three, four, or five buyouts, one GP after another. Investors were not keen on that, but they accepted it. What’s happening now is the same GP moving the asset from one vehicle to another. They want to hold the asset longer and offer regular liquidity options to investors, so those who want to exit can exit, and those who want to roll can roll.

Q: What role can secondary investors play in terms of permanent capital?

A: Right now, it is mainly traditional private equity vehicles, but there is certainly a trend towards permanent capital. The secondary market could go from $100 billion to $500 billion over the next 5-7 years, but no one knows what it will look like. Because we are a financial product, a liquidity tool, you should expect the market to look different from what we are today. We shouldn’t be relevant to a permanent vehicle with a liquidity mechanism. However, the parts of the market that do not have those structures will continue to grow, so we will continue to be useful.

Q: In the past, some GPs have attached liquidity mechanisms to their 10-year funds…

A: Only a tiny fraction of funds used such a mechanism, typically the very large US platforms. They didn’t develop because their usefulness was extremely limited. The way they work, LPs can propose a position to sell, a list of buyers puts forward a price, and the LP decides whether to transact. But LPs prefer to sell portfolios of 20-30 positions in one transaction.

Q: When assets are moved between funds managed by the same GP, what are the key negotiating points?

A: It is difficult to establish a standard. You could argue that any extra economics going to the GP takes profit away from selling LPs or take away from the returns for incoming buyers. Negotiations can be tense. Terms must not be too high, so the Advisory Committee of the selling fund can approve the transaction, and the buyers can decide to invest in this versus other opportunities.

Q: Under what circumstances would less than 100% of carried interest be rolled over into the continuation vehicle?

A: There may be carry that belongs to people who are no longer with the platform, so it won’t be invested into the continuation vehicle. Tax is another issue to take into consideration. We also see situations where GPs only want to roll over 50% because it’s the first time they’ve got carry and they don’t want to put everything back in. Alternatively, we see people who commit 100% and then want to double their exposure because they are so bullish on the company.

Q: What about terms for multi-asset GP-led transactions?

A: GPs will try to maximize value for themselves. It comes down to management fee rates, how carry is structured – multi-tier, single-tier, what kind of hurdle, and so on. Governance and legal rights are more standardized. I think there is more comfort because investors are more used to these transactions. There is also more guidance from ILPA, the SEC, and others who are quite close to transactions, making sure everything is done properly, and then there are fairness opinions and competitive processes. And with performing assets, the GP doesn’t have an incentive to sell cheap. It wants to crystallize a strong return and generate value from the original investment.

Q: Have you seen a step up in activity in Asia secondaries generally?

A: Intellectual property travels instantly from one part of the world to another. A few years ago, we started to see all types of transactions happening in Asia almost as soon as the innovation had happened elsewhere. The volume has been a bit more modest because the Asian market overall is smaller, but our team in Hong Kong is working on the same types of opportunities as our teams in London or New York. The only meaningful difference is the underlying assets – we see more companies or portfolios in Asia that are early stage.

Q: How do you get comfortable with valuation mark-ups on early-stage assets?

A: It’s an intellectual problem. If you buy a company valued at 20x revenue, how do you make money out of that? That has nothing to do with secondaries or private equity more broadly. We are seeing massive reorganization within economies – some sectors are hit hard, others do tremendously well. Each investor must develop their own macro call.

Q: How would you respond to a portfolio with China technology exposure in the light of recent regulatory uncertainty?

A: With any situation with risk attached a firm can either walk away or only look at transactions that can be structured with downside protection. For example, if it’s a portfolio of 10 companies, you need collateral. A firm might only buy 50% and the other 50% would be the collateral, or it buys 100% but where the portfolio is part of something larger and the bigger piece as collateral.

Q: What are the next market innovations to keep an eye on?

A: We need to remain aware of the products through which investors gain access to the primary markets and develop our own solutions accordingly. For a long time, access was through 10-year private equity funds, so we would buy positions in those funds. Now, there are more SMAs [separately managed accounts] providing access, which are very different from straight commitments to funds. A lot of capital is also coming from high-net-worth channels, via private banks.

Q: Can you envisage doing secondaries for impact funds?

A: I’ve been asked this question more often than questions about climate change-specific portfolios, but that will change – there has been a big push for climate change initiatives, more so than for impact or ESG. I can envisage providing a solution for an impact fund. It would be on a small scale because right now those strategies are raising limited amounts of capital.

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• Topics
• Secondaries
• GPs
• LPs
• Coller Capital
• Secondaries