Confused about how Secondaires work
I’m an undergrad trying to learn more amount secondaries transactions, and a little confused about the actual due diligence that goes into acquiring a secondary portfolio.
How do you really know you aren’t getting a crap deal from a secondaries acquisition? These funds can have hundreds of companies. Without going through each one in detail…how do you know? People keep talking about “top down models with economic sensitivities,” and I don’t understand this. Is the idea just get a discount good enough that you think even if a few are bad you’ll still be good overall? I’m having trouble understanding how the risk-return is calculated. I would really appreciate some insight on this.
it's easier than that userabc123, secondaries are units of closed-end funds sold before the fund exits its investment. The fundamental question you start to ask is not even related to finance but on human psychology and economics: Why is he selling it? and most often than not there are some circumstances that aren't even related to finance that push the LP to sell its stake at a discount. If not psychology/economics, there may be some legal issues (maybe the LP is in bankruptcy and needs to liquidate its unit, etc).
Answering the first question is not mandatory but it's extremely helpful to know how to approach the DD. So the next step, the "DD" is the same as how a Portfolio Manager would decide in what funds to invest based on who's the General Partner, what's their investment thesis, if your own analysis is at the same line as the ones the fund did for past acquisitions, etc. - the last one may be the part of sensitivty analysis, you just want to get an idea if the fund, according to your expertise, can properly value investments and what assumptions are needed to realize their IRR/carry. In case you don't agree with their past acquisitions then ask yourself if they may be smarter than you or just look for another fund.
I think that in secondaries they also look at NAV, but no idea as I'm not in it, just tried to redirect you to the correct path in understanding that most investments are ought to be done preponderently qualitatively and less quntatively as you imply.
Thank you for the response. As I read more into it I realized it has a lot to do with information advantage. Like you’re saying…why is the LP selling the fund? Pretty much comes down to the access to data you have on the assets/companies in the portfolio from a rating perspective…I.e who has supported them in the past.
But now this makes me even more confused. I understand all markets are psychological, but there has to be some kind of connection to the underlying asset. It seems that secondaries are just set to get farther and farther from this underlying value??
As more funds trade in secondaires based on “psychology” and “economics”…won’t this just lead to a bubble and a crash? If they literally aren’t even looking at the individual assets themselves? And the margins on secondaries are so massive as well? A lot of these transactions are worth hundreds of millions…and the volume just keeps going…
I’d appreciate yours and anybody else’s thoughts on this.
the game in secondaries is that you have more legal protections so you may not need to go as deep in looking at the assets the portfolio has
the GPs have a fiduciary duty to LPs, the owners that sell their assets also give some Reps & Warranties about the financial health of th asset, GPs don't get carry until they reach a certain % in returns, and so on
thr risk of having bad assets in the portfolio happens to all of funds but the fund's NAV is the main indicator on the financial health of the fund (think they have to even be audited enforcing more the protection of LPs)
so you don't need to be valuing the assets those companies buy, you just make some addumptions about the returns this fund will get durings its lifetime, you then do some market research on the industries it invests and lastly you coordinate with the seller the price and on the price you have some room of "deal structuring" as you can refund everything he paid since the fund inception and pay a lower price for his unit, you can left him keep some guture distributions for a lower unit price, etc.
As someone who works in secondaries, I will add that they do underwrite individual assets. Depends on how large the portfolio is but a common practice is to divide up the portfolio into say the top 70-80% of NAV and then focus on those assets. Depending on access to the GP (hence information advantage), you can sometimes have projected exits and therefore can zero in on the assets that will create the most value going forward. For larger portfolio sales there could be tons of GPs so information is limited, but the larger secondary funds typically already have exposure and know the GPs well so they gain an information advantage. The more concentrated a portfolio the deeper they go. Continuation fund diligence for example could have 1-5 assets where they will dig in the same way a direct / co-investor would.
But on more limited portfolio sale processes where there’s access to the GP, you’d be surprised at how detailed some of the diligence questions are (again, typically on the biggest value drivers).
One other thing I’ll add is, in today’s market you’re seeing a lot of “mosaic sales” where multiple buyers take different pieces of a very large ($1-$2bn+) portfolio sale. This is likely due to the dynamics described above, different buyers liking certain GPs more/less and capital/deployment constraints. So in the end, those large portfolio sales end up being more concentrated on a per investor basis.
Most LPs selling stakes on the secondary market are doing as part of their active portfolio management product (ie: denominator effect has them over exposed to PE) or because it's a tail end or FoF position they want information from or is just too expensive to maintain. These deals do tend to be more mechanical.
On the GP-led side motivation is really important and can be a variety of things. Most LPs want to buy into trophy assets over a second hold period. Leads here usually submit bids as a % of NAV but the better lead buyers are valuing the asset(s) on a relative an absolute basis.The diligence is an abridged version of what a GP would do, often a little more in-depth than a co-investor.
exactly - spot on. A lot of institutional investors have the same belief you do, they are afraid of the negative bias of people selling of crappy parts of their portfolios.
Hi there,
I had an Associate asset management interview today and aced it but after I had to do a quick excel test/basic data formula's/manipulation for 15mins, I unfortunately got way too nervous and only completed half of it and just froze, as I did really well on the interview, would they pass me regardless? OR would they pass me and weigh the interview more than the test result? Or would they need a certain benchmark result for the test in order to pass me/even consider the interview?
Also, should I ask them if I can re-do it or shall I wait for them to come back to me and see what they say?
Please let me know your thoughts below.
Thanks
Interested in this thread as well.
To anyone that works in secondaries transactions - how are secondary LP interests generally valued? What metrics are generally involved? How do you find comps for LP Transactions (if it's relevant to the analysis)? And if you're using comps, would you look at something like P/NAV of comparable LP secondary transactions?
Correct me if I'm wrong but I'm guessing NAV and cash flow yield are the primary metrics but other important metrics would be initial investment amount, duration, remaining dry powder would also be relevant.
Do secondaries firms often cover earlier stage strategies like venture or growth like buying stakes from a founding member of a tech company, and if so, how do these investments usually work? Or do they mainly buy stakes from larger portfolios from more established buyout groups?
Secondary firms absolutely touch VC and to a lesser extent GE.
Yeah firms do this but few dedicated to the strategy. There’s a couple popping up to take advantage of the white space.
Really? What are some groups that do?
Yes this exists. I do direct secondaries in vc-backed growth-stage tech. It’s a niche strategy but there are multiple funds in this space, someone listed below. My firm (not on that list, we’re a smaller player) specifically looks at sub-unicorns.
Sweetwater?
I cover secondaries, co invests and credit in my seat. It took awhile but I find concentrated lp secondaries to be the most fascinating and alpha generating part of the job. You can capture information asymmetry in ways that are unexpected. Gigantic lp deals with 20+ funds and hundreds of assets is different, and purely actuarial
How so, and what are some examples of ways to generate significant returns from these plays
Purchase discount, information access allowing to underwrite to a return competitors can't
Since you work on both co-invests and secondaries could you compare and contrast the differences in a GP-led process vs. a co-invest? Aside from what was noted above (more negotiation in a GP-led) would you say the asset underwriting process is similar?
Isn’t everyone doing gp leds and direct secondary investments (what’s the difference between this and co invests?)
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