by Greg Winterton

LP portfolios, traditionally the dominant part of the private markets secondaries industry, sat largely on the side-lines in 2020 due to a lack of forced seller situations, making GP-led deals the main driver of activity last year as private equity managers saw opportunities to double down on portfolio companies benefitting from a Covid tailwind and provide liquidity options for their LPs.

That’s not to say that the LP-led side of the secondaries industry was completely moribund last year. The smaller end of the market still saw some activity from investors such as family offices who had perhaps got a bit over-excited with their private markets’ allocations in the past few years, according to Jared Barlow, a Partner at Greenwich, CT-based private markets secondaries investor Kline Hill Partners, a firm with $2bn of AUM that invests in smaller secondaries deals.

“During the pandemic, some family offices seemed to come up short on cash for funding their portfolios or they simply needed to divert time and attention to their core business and core positions, so they sought buyers of non-core assets. This seemed to especially be the case if the family’s core wealth was related to one of the hard-hit industries like travel, energy, etc. Some of these family offices seemed to be among the more motivated sellers in the summer and fall of 2020,” said Barlow.

The first half of this year saw LP portfolios of various sizes return – slowly – to the market. It’s unlikely, however, that the short term will see a return to more of the traditional split where LP-led deals dominate activity in the industry.

“LP portfolios are starting to come back in 2021 but I don’t think they will keep pace with the rapid rise of GP-led deals to keep the percentage split equal to what we saw in 2020,” said Barlow. “It’s hard to say, but my guess is that in 18 months GP-led deals may comprise upwards of 60% of the market. This is not because the LP portfolios are not rebounding and increasing off the lower volumes of 2020, but because GP-led deals are proliferating so quickly.”

Those GP-led deals in 2020 tended to be better-performing companies with pandemic/lockdown-supported tailwinds; these deals still comprise the bulk of the activity in the space.

“GPs want to hold assets longer and retain their ‘trophy assets’ that are compounding value. They see it as a triple win: a win for LPs to have optional liquidity, a win for secondary investors to have a bite at the apple as a new investment, and a win for the GP to be able to re-invest in the asset and hold it longer to generate further returns,” said Barlow.

That’s not the only trend in GP-led deals at the halfway point of 2021, however. Barlow is beginning to see activity in the distressed arena.

“There has been a subset of GP-led deals this year that include assets that were hit during the 2020 pandemic and that are now rebounding off COVID lows and where part of the thesis for new investors is to ride the rebound,” he said. “I didn’t see this sort of deal in 2020, but there have been several such assets in 2021.”

The rapid rise in GP-led deals is creating more opportunities for bespoke alignment for secondaries investors and the smaller end of the secondaries market in particular enjoys nuances which provide some degree of differentiation from the market at large when it comes to deal flow.

“The GP-led transactions at the smaller end of the market are that much more bespoke and custom crafted. It seems to be more common to have multi-asset portfolios (rather than single asset continuation vehicles) and pricing that is truly negotiated with counterparties. It seems to me some of the large, ‘brand-name’ GPs essentially arrive at a price that they deem fair for a given asset and build the book of investors to consummate the deal. That doesn’t mean that the mid-large size deals are poor deals, but the GPs tend to have that much more bargaining power at the mid-size and larger end of the market. Overall, I think there is more inefficiency at the smaller end of the market, which can lead to more opportunity for buyers.”

The first half of last year saw a new record in private markets secondaries fundraising; some $42.4bn was raised in H1 2020, according to Preqin. The first half of 2021 has seen a significant pull back – $28.6bn of capital was raised from 21 fund closings in H1 this year but that’s still good for the second highest all-time, besting the $24.8bn that was raised in H1 2017. That money needs to find a home, and Barlow says that the secondaries industry will be able to provide plenty of opportunities for just that.

“I think the secondary market has strong tailwinds for growth in the coming decade. The GP-led deal trends, combined with the overall quantum of investment that has entered private markets in recent years, will result in private assets that naturally turn over and drive volume in the secondary market for the next 5-10 years, such that the market could become a multiple of its current size during that timeframe,” he said. “I’m optimistic that the secondary market will continue to be one of the best places in private markets to find attractive, risk-adjusted returns.”