Still plenty of fuel for the secondaries fire in older vintage funds

Private Equity International CFOs & COOs Forum panelists say the standard GP structure is straining under the weight of value yet to be realized.

This article has been updated and expanded.

Funds are, on average, getting significantly older than the traditional 10-year private equity structure – a boon for the rapidly growing secondaries market, panelists noted at Private Equity International CFOs & COOs Forum on Thursday.

PE Funds of the 2004-08 vintages on average retain unrealized value of 9.2 percent; this leaves between $175 billion-$180 billion of potential dealflow for the secondaries market, according to one panelist. That’s nearly three times the entire volume in 2020.

Extend that to the entire universe of active PE funds and there is nearly $3 trillion of unrealized value, the panelist added. In that light, the projection for a $1 trillion secondaries market begins to sound bearish.

Reflecting the meteoric rise of GP-led transactions targeting trophy assets, the concentration of unrealized gains clustered around the best performers. The top 5 percent of funds from 2007 and 2008 vintages still held 40 percent of unrealized assets, according to the panelist. This phenomenon is even more pronounced in the VC end of the market.

Assets are being held over a longer period. Analyzing over 15,000 realized transactions, the average hold increased from 3.8 years in 2010 to 5.5 years in 2019, according to the panelist.

The growing secondaries market will only be further fueled by the heft of aging assets, but the trend is also producing other strategies to keep funds running. Among them are continuation funds, of which many types have come into being, which includes traditional GP-stake sales.

These, of course, can present their own challenges, though at times a GP can entice a dominant LP in an existing fund to buy up the other LP interests, then roll that into a new fund.

The key factor in doing these deals is the credibility of the GP. Conflicts of interest are rife in GP-led transactions and other kinds of continuation funds. Panelists agreed that disclosure is key. Tax issues surrounding these transactions can also be tricky, and negotiating them can be time consuming. One panelist spoke of a 750-page document prepared for one transaction, which took months to produce.

The average fund life has been getting longer, another panelist said, reflecting longer asset holds and longer harvest periods. But the legal framework of partnership agreements has not changed. GP-led secondaries, continuation vehicles and other secondary technologies are putting downward pressure on that duration.

“Ten-plus-two just doesn’t work as well nowadays as it did, historically in part because managers are more inclined to hold assets for longer periods,” said a panelist, “particularly the best-performing assets.”

“The flexibility and creativity around these deals has increased enormously, because the large stock of assets to which this applies gets bigger every year. The 10-plus-two construct is creaking at the seams.”

Additional reporting by Michael Baruch