A secondary thought

Secondaries are still uncommon in the asset class, but certain fundamentals may drive demand in the future, writes Amy Carroll.

Just 15 percent of investors expect to make commitments to infrastructure secondaries funds in the next 12 months. This compares with 33 percent in private equity, and reflects the relative immaturity of the secondaries industry in the asset class.

“Pure secondaries funds are relatively uncommon still in the infrastructure space,” says Bruce Chapman of placement agent Threadmark. “Many of the participants in secondary transactions manage pools of capital that can be deployed into a range of primary, secondary and co-investment situations. The underlying managers of these pools include fund of funds managers as well as pension funds and insurance companies.

“Part of the reason for the lack of specialisation is the relatively small number of typical secondary transactions and the general immaturity of the infrastructure market. Another is that infrastructure is often viewed as a long-term, liability-matching asset class, meaning that there are fewer sellers,” says Chapman.

Indeed, only 2 percent of investors say they expect to sell infrastructure fund stakes over the next 12 months, while 5 percent say they expect to be buyers. More than half, 52 percent, say they will not be active in the secondaries market at all, while a further 35 percent remain unsure.

However, as primary infrastructure fundraising escalates dramatically – 2018 was a record year and 2019 remained strong – the growth of a secondaries market seems inevitable. There are several other fundamental drivers too.

As new investors continue to seek exposure to the asset class, the secondaries market can provide an efficient access point. It can help to mitigate the J-curve effect by enabling investors to buy into portfolios with assets already in the ground. Furthermore, there has proved to be a fundamental mismatch between the longer-holding periods associated with infrastructure and some of the early investors in the asset class.

Given the quality of assets in many portfolios, GPs and investors would often like to extend their hold. Yet that creates a misalignment with investors that want or require liquidity.

GP-led secondaries

This is leading to a spate of GP-led secondaries across all alternative asset classes. According to Palico, $22 billion of these types of transaction were completed in 2018, up 30 percent on 2017 and triple the amount seen in 2016.

Once viewed as a last resort for sponsors struggling to get a primary fundraising underway, GP-led secondaries are now an accepted form of portfolio management, providing additional funding, time or improved economics for the manager, while offering liquidity to investors.

The stigma has faded, and the biggest and most successful managers are increasingly pursuing these deals in order to extend the hold periods on their standout assets. Nonetheless, the growing prevalence of GP-led secondaries has raised difficult questions around best practice.

Although these transactions should represent a win-win, investors in early deals sometimes felt manipulated. Forced timelines were a particular bone of contention, but lessons have been learned. When asked about restructuring processes on old funds that seek to move assets into new vehicles, more than 60 percent of respondents, surveyed across all private markets asset classes and with experience of such transactions, say they were given enough time to decide whether to roll over or cash out. Inevitably, however, this leaves 40 percent that felt rushed.

“There is a natural tension between keeping the timeline tight to ensure price is maximised in these deals while also providing enough of a window for investors to react to the offer that is being presented to them,” says Gerald Cooper, a partner at Campbell Lutyens. “We do have sympathy for LPs that may be getting multiple election notices at the same time, which becomes extremely difficult to manage. Where possible, we advise our clients to provide a well laid-out timeline so that LPs are not blindsided by the election period and have time to plan.”