In a fireside chat in March during UBS Alt+Shift Alternatives conference, Sijin Choi, Team Lead Multi-Managers Private Equity APAC, Executive Director, UBS Asset Management explained how investors can access primary private equity investments through secondaries, the advantage of secondaries for investors, and where the next opportunity is for him.
Private equity secondaries are secondary funds that purchase existing interests or assets from primary private equity fund investors. At UBS, private equity secondaries can be at significantly lower price points, such as U$50,000, than private equity.
Private equity is viewed as a high return investment, relying on very patient capital. Often, managers in private equity can invest in a portfolio of companies and take an active role to help manage this portfolio. Sometimes, private equity managers help to actively manage individual companies in their portfolios.
The point of investing in private equity over a long holding period is to maximise the earnings potential of the portfolio, and to sell these portfolios at a decent profit. By contrast, managers who invest in public companies tend to be passive; they are able to buy and sell stocks more often. Publicly-listed companies are, of course, very liquid compared to the illiquid private equity sector.
In sum, the biggest drawbacks of investing in private equity are its long-term holding period which can be upwards of 10 years, illiquidity, and large ticket prices.
“Private equity managers are incentivised to take more risk. One of the biggest drawbacks with private equity investment is lack of liquidity. There are very limited liquidity options with respect to private equity investment, but with the right execution, investors should be able to enjoy outsized returns relative to any other asset classes,” explains Choi,
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The second drawback of investing in private equity is the minimum amount which is likely to be large. “That’s the biggest drawback of private equity investment. The minimum cheque size is likely to be larger than any other asset class in the investing universe, particularly if investors want to build a diversified portfolio,” Choi says.
In a typical primary investment, it will take more than 10 years to get fully liquidated because it takes about 4-5 years of building a portfolio and then another 4-5 years to liquidate it.
Secondaries enable portfolio diversification, they come in smaller ticket sizes, and there is the ability for investors to exit the investment before its maturity date. Hence, time to liquidity is significantly reduced compared to primary investments in private equity. In addition, secondaries carry less risk than primary investments.
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“Secondary investments really enabled portfolio diversification. Almost immediately, portfolio companies are much closer to exit because it's like investing in the middle of the investment life,” Choi says.
“There is relatively limited risk with secondary investment when you compare it to primary investment because there is no blind pool. We know what we are buying into with secondary deals. Since we invest in secondaries at a discount, most of the time investors can enjoy almost instant uplift of the valuation,” he adds.
UBS has a Private Equity (Lux) Evergreen Secondary Fund, a semi-liquid secondary fund in an open-ended structure, Choi says. It addresses the illiquidity issue by enabling investors to redeem 5% of the fund’s NAV per quarter, or 20% a year, although investors cannot redeem anything in the first 12 months of investing. The minimum commitment or investment is US$50,000, and accessible to smaller investors, Choi indicates.
Pricing of secondaries
Since it's a function of supply and demand, with the abundant liquidity in the market in the past 5-6 years, pricing was not really cheap for secondary investments. Both GP-led private equity and LP-led investments experienced elevated pricing.
A private equity firm is called a general partner (GP) and its investors that commit capital are called limited partners (LPs). Limited partners generally consist of pension funds, institutional accounts and wealthy individuals.
“We focus more on GP-led transactions and less on LP-led deals. On the GP side, I wouldn't say it's cheap but pricing can be better than some LP-led deals,” Choi points out. “it's a challenging environment from the pricing perspective, but this area is the best segment that offers the best values in the secondary market.”
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Currently, the secondary market rate is at a discount to NAV, an indication of more supply than demand. This is because primary and secondary deals have not been unaffected by more expensive capital following the accelerated hikes in policy rates by the Federal Reserve.
“In terms of pricing, the secondaries market is not really immune to what happened with the other asset classes,” Choi acknowledges.
Prefers middle market deals
Choi says that he has a preference for middle and lower middle market deals. These are companies with that have less than US$1 billion in PE equity backing with around US$500 million being the so-called sweet spot.
When asked what are some of the popular underlying assets that work well for secondaries, Choi says there is interest in media and tech. “We recently closed one continuation deal by Pamlico Capital, which we backed.” Pamlico focuses on software and media sectors in the US.
The most recent opportunity is with Pacific Equity Partners on a single tertiary education asset. “It’s a New Zealand based tertiary education company with a focus on vocational education. We know this manager very well and think of them very highly. It’s a very institutional group and one of the best names in Australia,” Choi says of Pacific Equity Partners.
The asset, Up Education, is the largest tertiary education company in New Zealand, and 9 times bigger than its nearest competitor. Up Education is the rebranded Tertiary Division of ACG following the separation and disposal of the ACG K-12 Schools. It educates around 9,000 students each year, and employs some 1,200 staff across 40 campuses across New Zealand and Australia.
“They essentially want to replicate the success in New Zealand to Australia. It’s why we like this investment, the largest tertiary education company in New Zealand with diversified revenue streams and attractive financial profile,” Choi says.
