A large majority (80%) of secondary fund managers expect 2022’s deal flow to exceed 2021’s as they observe a mature and robust market, on track to break more records, according to Investec’s fifth Secondaries Market Report.
A large majority (80%) of secondary fund managers expect 2022’s deal flow to exceed 2021’s as they observe a mature and robust market, on track to break more records, according to Investec’s fifth Secondaries Market Report.
Headlines about inflation, supply chains, lockdowns in China and of course the war in Ukraine are all front of mind for investors. But in the midst of these events, the private equity industry is having a strong year – with client conversations and industry surveys pointing to high levels of optimism, especially in Europe. How long it will last, nobody knows.
With the global secondaries market having reached record volumes in 2021 – surpassing $130bn – managers operate in a more mature, robust sector that is now an essential part of the liquidity package for GPs, advisers and banks, a position solidified through the pandemic.
Continuation vehicles are now considered standard exit avenues for GPs. GP-led secondaries have grown steadily in recent years, but this accelerated in the past 12 months: 97% of respondents declared they currently, or intend to, participate in such transactions, versus 86% the year before. In fact, deployment into GP-led solutions is now almost on par with LP portfolio sales.
Moreover, as debt capital markets closed during the pandemic, secondary funds provided liquidity for companies that needed it through preferred equity transactions.
Over the past year, single asset deals increased in both areas, with 76% of GPs reporting openness to GP-led deals with one asset, and 67% saying they would consider single asset preferred equity transactions. In a challenging environment, managers felt more comfortable investing in individual companies or small numbers of businesses, where they could conduct bottom-up analysis, than in tail-end funds or diverse portfolios which are more heavily influenced by the macroeconomic environment.
However, GP-led solutions may have reached peak popularity as investors look to rebalance their portfolios by prioritising traditional LP trades. Most managers (59%) believe levels will remain similar, and 28% expect only a slight increase.
Preferred equity transactions have declined as debt markets reopened. Only 30% of participants carried out a preferred equity transaction in the last year, down from 69% in the previous year, and most believe activity will be broadly similar this year.
Instead, 70% of investors expect to be more active in the LP market over the next 12 months.
According to half (48%) of respondents, heated competition for high-quality assets is pushing valuations higher, while another 21% attribute higher prices to the level of dry powder in the market. GPs are facing pressure to deploy yet are being more judicious than in previous years: last year, 68% of managers thought deals were being done that should not be, compared to 41% this year.
Financing has become a vital tool in counteracting high valuations. The primary use of financing, according to respondents, is to enhance returns (73%), with more than half (55%) targeting unlevered returns of 15-25%. Historically considered risky, 97% of surveyed managers use some form of financing, up from 84% last year, reflecting a more mature market.
Subscription lines are the most popular type of financing, used by 97% of respondents, a sharp rise from the 25-30% of funds that used these facilities just five years ago. Asset-backed solutions, including hybrid solutions, are also better accepted, with 50% of participants using these facilities, up from 39% last year.
For GP-led deals, where GPs are looking to enhance returns but also to bridge a refinance of underlying portfolio companies or bridge an exit, subscription lines at the continuation vehicle are the financing of choice, preferred by 62% of those surveyed. The majority of GPs (60%) also use subscription lines to fund LP portfolio sales, a significant increase over last year’s figure (25%).
