By Hamlin Lovell, NordicInvestor
In public equity markets, the secondary market is many times larger than primary issuance almost everywhere (except perhaps in a few frontier and emerging markets during their first few years). In private equity, the reverse is true, but the secondary market has grown significantly over the past decade, from c. $10 billion in 2008, to a record c. $74 billion in 2018 (according to Greenhill’s 2018 Secondary Market Update). This now represents about 2% of global private equity assets of $3 trillion (per the 2018 Preqin Global Private Equity and Venture Capital report).
“The growth is mainly driven by the primary market, which has been very strong since the global financial crisis. Turnover rates are also increasing as limited partners (investors) use the secondary market as a tool to dynamically manage and rebalance portfolios”, says ODDO BHF Managing Director, Jerome Marie, who co-manages the strategy with two other partners, Gilles Michat and Ferdinand Dalhuisen. In addition, “a new driver for the market is that general partners are proactively offering liquidity to their existing LPs in exploring GP-led secondary transactions” he points out. Firms like Nordic Capital, TPG, or Warburg Pincus are amongst well-regarded GPs who embarked on that road lately.
This generates an expanding opportunity set for private equity investors such as ODDO BHF Private Equity, which has invested €2.1 billion into primary and secondary private equity, over the past 20 years. The former strategy has generated an IRR in excess of 10% since inception, when secondaries has delivered an IRR in excess of 15% since 2010. The absence of financial leverage is one factor that distinguishes ODDO BHF Private Equity from some other firms.
Marie finds it natural and logical for the secondaries to have outperformed the primaries. “There is no ‘blind pool’ investing. Besides, these are mature assets, acquired six or seven years after a fund has launched, and we have a good visibility on both liquidity and upside potential”, he says. “They are well diversified portfolios, and mitigate the J-curve effect. They are expected to rapidly deleverage and make distributions”, he adds.
ODDO BHF Private Equity is currently fundraising its next generation of secondary programs with an aggregated target size of approximately €450 million, of which almost half of the capital has already been successfully secured, mainly from institutions, HNWIs, and a sizeable investment from the Group as well.
The firm hunts for value in deals sized between EUR 5 and 50 million. With deal flow in excess of €5 billion a year, it can afford to be very selective.
Buying at a discount
ODDO BHF Private Equity is able to potentially acquire at a discount partly because there is sometimes little or no competition for these assets, which can be sourced from other investors, managers, brokers and investment banks. ODDO BHF Private Equity strong network and relationships will often lead them to be granted an exclusivity period.
The ability to buy at a discount does not arise from taking a contrarian view on out of favour assets or managers. “We are genuinely a growth buyer and the discount is only the end result of our analysis and our capacity in negotiating better than market prices”, says Marie. ODDO BHF Private Equity is generally buying secondaries managed by well-established, blue chip managers, who have often launched one or two other funds subsequent to the one being bought. “They are performing funds in carry mode that best align interests between GPs and LPs”, he adds. Managers have included Carlyle, TPG, EQT, Bain, Apax, Oaktree, and IK Investment Partners.
Leveraging market intelligence
ODDO BHF Private Equity has an informational advantage from their 20 years’ experience across 300 partnership investments and the firm’s broader investment activities. Quite often when looking at a secondary opportunity, ODDO BHF Private Equity will already have been invested in the primary fund, or another one run by the same manager, which may have some common holdings. ODDO BHF Private Equity’s secondaries team can leverage the expertise and knowledge from ODDO BHF Group’s 2300 staff, which include ECM (equity capital markets), DCM (debt capital markets) professionals, and merger and acquisition analysts. All in all, ODDO BHF Private Equity can look at companies from multiple angles. This means that ODDO BHF Private Equity will often have an intimate knowledge of underlying portfolio companies, which fits perfectly the firm’s DNA of fundamental, bottom-up analysis.
Just over 80% of secondaries invested in are for buyout funds. This is partly driven by market fundamentals but equally important by ODDO BHF Private Equity desire for more predictable and less volatile returns, relative to other private equity sub-strategies such as venture capital. The objective is also to monetize investments within a few years, via distributions.
“Very few teams are truly global”, argues Marie. Though ODDO BHF Private Equity has a global purview, in practice most investments have been in Europe and North America. Recent examples have included a portfolio of blue chip US buyout funds and a French mid cap buyout fund.
ODDO BHF Private Equity has a strong pipeline of dealflow, and this might even get better. Marie feels confident in stating that private equity is very late in the cycle. He will not predict the timing of any correction, but does expect that it would bring a lot of opportunities. “A market correction is a challenge but it is also a blessing. It would lengthen duration, increase volatility, and reduce visibility of liquidity, that would ultimately create more motivated sellers and better pricing. This could give us the opportunity to buy aggressively at deeper discounts”, he expects.