The Oregon Public Employees Retirement Fund had some fairly choice words to describe the state of the private equity secondaries market, as sister publication Secondaries Investor reported last week. Amid some emotive language there were some fair observations; not all of them as negative as they first seem.
“As the secondary market is growing and maturing rapidly, we are increasingly seeing innovative but complex and conflict riddled transaction proposals,” the pension noted in a January presentation outlining its private equity annual review and plan.
Yes, the secondaries market is growing and maturing rapidly; $74 billion-worth of transactions happened in 2018 and the mix of deals has shifted such that 32 percent of the market now comprises GP-led deals such as tender offers or fund recapitalizations, according to advisory firm Greenhill. Innovation abounds – new deal types seem to spring up on a monthly basis – and there is complexity (although any area of corporate finance appears complex if it is new and unfamiliar). Conflict riddled? Yes, but are conflicts of interest not present to a greater or lesser extent in any transaction or relationship? They are there to be managed.
“More recently, we are seeing proposals to recap more nascent partnerships in ways that start to break down GP:LP alignment,” the pension observes.
We have heard of incidences in which funds propose some sort of recapitalization ahead of their 10-year end date, but not many. Can it ever be justifiable to recapitalize a seven-year-old fund? It’s conceivable that additional capital could be needed to realize some upside to an investment that wasn’t foreseen. Perhaps an unexpected regulatory change merits an M&A spree for which follow-on capital is required. In the words of another adviser, Campbell Lutyens’ Andrew Sealey, “the bar is higher to prove that it’s actually in the interest of the majority of LPs” when recapping a younger fund. That does not mean it shouldn’t be done.
“While all of this has a place in a maturing private equity industry, the aggressive pace of innovation may suggest that secondary buyers have more appetite for deals than the current market can satisfy,” the pension continues. It’s tough to paint innovation as anything other than a good thing, especially in an industry in which the technology – the buyout fund – has not developed much since the ‘90s.
As for the suggestion that buyers may have more appetite than dealflow can satisfy; it is undeniable that there is a lot of capital out there ($192 billion of dry powder including leverage, says Greenhill), which is keeping pricing up. Yes, this might drive “aggressively” paced innovation, but it also drives better outcomes for selling LPs.
This may be a fairly rose-tinted view of what are valid concerns relating to a rapidly growing market. Oregon is, as one consultant tells us, one of the savviest PE teams in the US; their concerns should not be dismissed. Their thoughts should be considered a call to market participants not to avoid secondaries transactions, but to make sure they do them right.
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