Five Questions with Patrick Knechtli of Aberdeen Standard Investments on GP-led secondaries

Patrick Knechtli is the head of secondaries at Aberdeen Standard Investments. He spoke to Buyouts about new ILPA guidelines and how the secondaries market would react to a recession.

What do secondaries look like on your side of the market, which is the smaller side – what is pricing like, and what kinds of deals are you seeing – GP-led restructurings, traditional portfolio sales, etc.?

One of the classic areas where we see deal flow is coming out of our primary platform and tends to be the smaller cap space. These are typically funds that are not coming onto the secondaries market very often that people on the buy side are not very familiar with, but where we hope we have a strong relationship with the GP and we have better insights into the portfolio.

I think for most secondary deals, pricing is strong at the moment. You need to be able to justify strong pricing; you need to have real conviction in the underlying assets and even though you may be paying par or even a premium on occasion that you can still generate a good return from the underlying assets. Relationships and insights, for us, are absolutely key.

On the GP-led side, we are seeing a whole variety of different types of deals come to market. We would hope that our primary platform is helpful in that we’re attractive as a counterparty for the GPs in those deals, combined with the fact that we have a lot of secondaries expertise in doing these types of transactions. A lot of the GP-led deals tend to involve more concentrated portfolios. In many cases as few as two or three underlying assets, and in that case quite often we’re doing much more of an investment-style diligence on those. We sit next to our co-investment colleagues and they help us in those situations. Those are kind of the areas that we’re looking at. We’ve also got some fund-of-fund interests, as well. Fund-of-fund interests are quite difficult to buy, if you don’t have insights into the underlying portfolio. That really goes to our existing platform.

What is your view on single asset or concentrated asset deals? Have you participated? Do you have concerns?

We participated in one last year and a number of others we looked at and ultimately declined. You have to be very clear about what the motivations are for the manager for doing a single asset deal. Why the specific asset cannot be sold just through a regular M&A process and why a secondary deal is a perfect solution, both for the people on the buy side but also for the existing investors who want to make sure they’re getting a fair price on the way out. That is one of the key considerations on the single asset deal situation.

For us on the buy side, it is a lot about a level of due diligence that is similar to doing a co-investment. It’s actually digging into that specific asset and meeting the management of the underlying company and in some cases, taking on sort of fresh third-party diligence on the market, on financial and legal aspects of the company; more akin to doing a direct investment because you’re taking on more risk. The other thing to consider is the alignment with the manager going forward, presuming they continue to manage the asset. It’s making sure what alignment you have with them in the future.

There’s been a lot of chatter that we’re about to hit an economic downturn. If that happens, how would the secondaries market be affected?

We have a good precedent in what we saw in the global financial crisis in 2008/2009. There was an extreme reaction where there was pretty much a standoff between buyers and sellers at that time. Secondary buyers working on the basis of visibility of cash flows. When they look at a portfolio, they’re trying to see when the underlying assets will get sold and will be turned into cash that can then be distributed back to them. When you hit a recession, the exit windows become closed or restricted, exit timelines move out and that obviously changes your analysis dramatically, which then drives buyers to bid at discounts to NAVs.

There’s a time lag in the reporting cycle for private equities. It takes a little while for a downturn in the stock market to be translated into a downturn in private equity valuations. Secondary buyers will anticipate those valuation decreases and will end up bidding at quite a big discount. During the global financial crisis, 40 to 60 percent discounts were being offered for private equity assets. Part of that was just caution, part of that had to do with the time lag on the fund valuations. For the sellers that discount will ultimately be translated into a loss in their P&L, and many of them weren’t able to stomach that loss.

We saw in Q4 last year there was quite a big tick down in stock markets, and I think everybody on the buy side, in the secondary world, was worrying how that would be translated into Q4 valuations. I think that’s led to a slightly quieter Q1 and most people are pleasantly surprised that there wasn’t such a material impact in the private equity valuations in Q4. Activity has ticked back up again, as a result.

What can we expect under new ILPA GP-led restructuring guidelines?

These guidelines are very welcome. You see more and more acceptance of these GP-led deals among the manager community, but it’s also led to new issues. GPs can get a bit bogged down in these processes and can alienate some of their investors. Quite often the institutional LPs don’t have a lot of resources. They’re spending most of their time doing new investments and then suddenly to be presented with a whole load of proposals around the GP restructuring can be very time consuming for them.

LPs are typically quite suspicious that the buyers will always know more than them. They’re also suspicious about GP motivations. Are they moving the goalpost? Are they trying to get additional economics out of a portfolio that hasn’t done that well? One of the key things [the guidelines] highlight is that there should be equal treatment for existing LPs, as well as the buyers. Anything you give in terms of detailed forecasts of an existing portfolio to the buyers should also be made available to the sellers, which maybe wasn’t always done before. That specific point around that level of transparency is important.

Who are the sellers driving secondary market activity today? What are you seeing?

It’s changed over time; pre-financial crisis, it was the banks, which were the largest source of deal flow and then a lot of them sold out. The last few years it’s really been pension funds re-balancing their portfolios. A vast number of funds have a whole load of manager relationships and they tend to have quite limited resources. They have small teams managing very large sets of relationships and a number of investors have decided to cut down on those core relationships. They’ve ended up having a bunch of funds that they would put in their non-core, or legacy bucket, and some of them have held on to those funds and others have decided to sell off those non-core funds, and non-core managers, and then re-utilize the capital and make bigger investments in their core relationships.

Pension funds have been a big source, endowments as well have been more tactical sellers of assets, and the GP-led space has been a bigger driver. I think it was just under 30 percent of the volume last year. Last year, I think a record $74 billion was transacted. The fact that almost a third of that came from GP-led deals is pretty significant. There’s been a lot of growth in that market.

Correction: Part of quotes in the fifth paragraph, and the first paragraph under the fourth question, were changed to more accurately reflect what the speaker said.