Harvard, Yale and other large university endowments recently made news by contemplating selling some or all of their private equity (PE) holdings on the secondaries market to enhance liquidity. Should advisory clients buy what they’re selling?
We spoke with Craig Robson, Founding Principal and Managing Director of Regent Peak Wealth Advisors; Paige Canavan, Senior Investment Manager at Opto Investments; and Stephen Tuckwood, Director of Investments at Modern Wealth Management.
We asked each of them: With many endowments looking to liquidate their private equity exposures, how should advisors be approaching secondaries as an opportunity for their clients? What are the pros and cons? What should advisors know about investing in secondaries?
Their responses follow.
Craig Robson, Founding Principal And Managing Director, Regent Peak Wealth Advisors
Regent Peak continues to have conviction in adding private equity, specifically secondaries, to an overall portfolio construct. The secondaries market continues to provide investors with opportunities as the overall private equity asset class grows, forming the pool of potential secondary investments.
Increased turnover in overall PE exposure also provides greater opportunities, such as the recently announced PE liquidations from the respective endowments of Yale and Harvard. These endowments are raising their overall portfolio liquidity via PE liquidations, which in turn should offer embedded values in purchasing these portfolios in the secondaries market.
Yet, investors need to fully understand what they own and why they own it before considering PE secondaries. These investments are illiquid and best suited for investors who have a longer-term outlook and significant liquidity to support their lifestyle needs. Additionally, PE secondaries generally have different fee structures than public investments and typically may not be used as collateral sources for lending facilities.
From an advisor’s perspective, diligencing and ongoing monitoring of these investments require qualified resources, which some advisors may lack. Advisors will also need to dedicate additional time to educating clients on the overall pros and cons of considering PE secondaries within a broader portfolio allocation.
Paige Canavan, Senior Investment Manager, Opto Investments
Secondaries have unique benefits that can make them an intriguing opportunity for RIAs who are investing in private markets. The benign exit environment the past few years has expanded the opportunity set. General partners (GPs) are facing increased pressure from limited partners (LPs) for distributions and institutional LPs are seeking alternative avenues to manage their portfolios. With a wide range in strategies and approaches, the secondaries ecosystem can be complex, but it is possible to simplify it into two main categories: LP-interest and GP-led secondaries.
Relative to primary PE commitments, LP-interest secondaries can provide investors diversified manager and company level exposure, blind pool risk mitigation, J-curve mitigation, faster returns of capital and potential early markups as assets are priced to net asset value (NAV).
Working with an experienced secondaries manager with a strong network is critical for sourcing, access to deals, quick execution and potentially more favorable pricing. Discounts on entry should be a portion of returns, but asset appreciation should be the larger driver. Investors should look for managers who have a proven ability to buy attractive opportunities at a good price.
GP-led secondaries strategies tend to focus on single asset investments versus a portfolio. There is a potential for higher returns in this more concentrated strategy, but it carries greater risk. This is about asset selection as discounts are not typically common. There has been meaningful growth in the GP-led market with an expansion in use of continuation vehicles as a path for liquidity. Investors should be thorough in the assessment of continuation vehicles, evaluating the quality of the asset and assessing proper GP and LP alignment.
Stephen Tuckwood, Director Of Investments, Modern Wealth Management
Secondaries have been growing rapidly given the lack of distributions from PE primary funds. The dearth of traditional exit activity has led some LPs to turn to secondaries as a source of liquidity, selling stakes in their PE portfolios. To “make the market,” the existing LP sells at a discount to NAV as an incentive to the secondaries fund to step in. The size of the discount is a function of the quality of underlying assets, but also the amount of capital chasing deals.
In our view, the discount should not be the only component of returns, but rather the ability of the GP to increase value in their underlying portfolio companies. This means investing with a seasoned secondaries manager who is allocating to top-tier GPs, and avoiding secondaries funds where the only driver of returns is clipping the initial coupon, as they are reliant purely on doing more deals. Investors also need to ensure they’re not inheriting the valuation problem seen in many 2021 vintage funds, which is partially causing the exit issue.
Secondaries can be a great way to gain “core” PE exposure with instant diversification across approach, manager/GP, underlying portfolio companies and, importantly, vintage.
Jeff Berman, Contributing Editor and Reporter at Wealth Solutions Report, can be reached at jeff.berman@wealthsolutionsreport.com.
