Secondary PE market primed for strong growth
The secondary market is on an upward trajectory. More institutional investors are looking to streamline their holdings and take an active approach to portfolio management. This, in conjunction with travel restrictions resulting from the Coronavirus pandemic, has led to investors becoming more comfortable with the concept of trusting an online platform.
Julien Gervaz is the CEO at Palico, an online platform that facilitates secondary transactions. He gives more detail on the outlook for growth in this market: “Everybody knows that the current hot spot in PE is in the secondaries market. LPs are getting more familiar with it and last year saw almost $90 billion in secondary transactions. Investors are beginning to understand that if they want to invest in private equity and not suffer through the J-curve, they have to look at the secondary market.”
An active secondary market can also alleviate pressure on under-resourced institutional investors. “Some institutional PE portfolios include dozens, if not hundreds of funds, including vintages of around 15 years, managed by a lean staff complement with multiple jobs. So naturally people are starting to think about pruning their portfolio and reducing the number of relationships they have with managers,” Gervaz notes.
The drive to go green is also encouraging growth in the secondary space. Gervaz comments: “The increasing importance of ESG and climate change awareness means institutional investors are selling some of their non-green assets to better align their investment programme with their ESG goals. Typically, we see some endowments and foundations using the secondary market to reduce their oil and gas exposure in their private equity programme to align with new guidelines.”
On an even broader scale, there is a culture change taking place among institutional investors which is promoting their increasing participation in the secondary market. Gervaz observes: “The secondary market is fast becoming a tool to help investors be more active in their portfolio management. This is a huge shift. Nowadays, selling a PE investment on the secondary market no longer means you’re distressed. The stigma is gone.”
Palico provides liquidity to LPs through its secondary marketplace. If institutional LPs want to sell a fund or even many funds, they can list them on the firm’s online platform. They will be matched to relevant buyers. The buyers then get in touch with the sellers through the platform, and the transaction is initiated.
“Private equity is currently one of the least liquid asset classes. If we can help make it a little more liquid, we’re really contributing to improving the industry for the LP community. If you look at what has been done on the public side in the 80s was standardise trading information and the logistics associated to it which made everything easier. PE is usually 10 to 15 years behind the public markets in the way information is handled. So, if we can bring innovation to PE it makes a huge difference.”
Palico targets smaller transactions – usually deals below USD20 million, with a sweetspot between USD3 million and USD15 million. “Brokers and human intermediaries aren’t interested in small and simple lines while the platform doesn’t discriminate according to size. Plus sellers and buyers don’t need the heavy weight of legal and admin documentation for such small transactions,” he says.
When it comes to encouraging growth in the secondary market, Gervaz says the Covid-19 pandemic has underscored the benefits of Palico’s digital platform: “It’s odd to say but Covid and confinement has helped us grow faster. Encouraging people to do business online is very much aligned with being confined. So, we’ve seen a sharp increase in activity.”
He points out: “Palico is very user friendly and intuitive. We explain to new members how it works, give them a demo and after being vetted by our internal compliance department, they are onboarded. After that, they’re happy to handle it themselves and they do it very well. The best analogy is the travel business: for a flight, even with a hotel room and a car, everybody does it online and on their own. So it’s just a matter of time until smaller transactions are done this way as well.”
A key characteristic which can provide an institutional LP comfort with selling PE funds online is that the platform is solely accessible to institutional buyers. Gervaz comments: “We only have institutions that are accredited and regulated on the platform. We really spend a lot of time on making sure of this. We have the biggest pension funds and most prominent asset managers active on the platform, together with hundreds of family offices and smaller institutional players. It’s a private club with very restricted access which ensures a hiqh-quality, professional environment.”
Although the elements for full scale LP adoption are there and activity is increasing, challenges remain. There are two main hurdles facing advocates of the secondary PE market. The first is related to awareness and education and the second is linked to digital adoption.
“The fact is a lot of LPs – even some of the most sophisticated and long-standing PE investors – don’t have a lot of experience transacting in the secondary market. We need to educate them on what it means to sell some of their PE investments The second challenge is about the adoption of an online platform. We need to reassure LPs of the safety and security we have provided which is a top priority for us at all times. They need to feel comfortable making these trades through a screen,” highlights Gervaz.
A new wave of secondaries
The implications of this could be significant for LP investors and the secondary market as a whole. For LPs, there is suddenly an opportunity to divest a larger swath of their PE portfolio, which may include PE investments sitting in older vintages. Palico reports that for 2007 to 2012 vintages, there is an estimated $750bn worth of NAV sitting in PE funds. Those older funds have amassed a vast number of smaller lines which now remain on investors books. Now, LPs can look at those lines with a renewed perspective. “’What lines are administratively detrimental?’ or ‘what do I want to divest to in order to shift towards a new investment strategy?’ These are the questions we want all LPs of all sizes to ask themselves confidently” – said Gervaz.
The exact potential is hard to measure just yet, but with numbers at that scale, the market is poised to see a new wave of secondaries where divesting becomes a simple and proactive exercise. However, instead of blockbuster sized deals, the growth will come from volume as frictions are reduced for LP-led transactions.
“You could boil down our efforts for the secondary market into one word – access. Access, to the secondary process, to secondary buyers, and to liquidity for PE fund stakes that traditionally didn’t have the size to be marketable.”
This access has begun to unlock potential for LPs and continues to chip away at the idea that PE is a highly illiquid asset class when, in reality, there is already a marketplace for it.
Julien Gervaz joined Palico as CEO with the ambition for Palico to become the leading platform for PE fund secondaries. His career matches his role at Palico, at the intersection of finance, strategy, and technology. Julien started his career in trading and equity research at Raymond James, then joined Advention, a strategy consulting firm advising PE funds and global companies. Later on, he joined the buy-side and had stints in PE, hedge fund and VC, before shifting into operating companies across e-commerce and digital platforms. Julien earned a Master’s degree from EM-Lyon and an MBA from Wharton.