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The Artisan Podcast: Private Equity Secondaries: Beneficiary Of Rising Distress

Secondaries have historically provided superior returns and risk-adjusted returns compared to private equity, venture capital and most other alternative investment categories. Better yet, purchase discounts tend to widen during periods of stress, like we are experiencing now.

On Northland’s upcoming panel, Joseph Abramson leads a particularly insightful discussion with some of the leading minds in this space:

• Mike Pugatch – Managing Director at HarbourVest Partners, LLC

• Patrick Gerbracht – Managing Director at Portfolio Advisors, LLC

• Patrick Knechtli – Head of Secondaries, Private Equity, abrdn (formally Standard Life Aberdeen plc)

Key issues to be discussed on this podcast

• How do investors make money, or avoid losing it in 2022?

• How are leading managers protecting investors from inflation and rising rates?

• Why a recession might be good news for returns?

Make sure to check The Northland’s YouTube Channel for more episodes.




Joseph Abramson, Mike Pugatch, Patrick Gerbracht, Patrick Knechtli

Joseph Abramson 0:12

Welcome to the artisan podcast where we share insights from the world's leading investors. Today, we have three of the brightest minds in private equity, all of them focused on the secondary market. secondaries are where you buy stakes in private equity companies or funds from other funds or investors rather than directly buying the company yourself. at Northland, we view secondaries as highly attractive because they have the best return and best risk adjusted return of any investment category. They're also lower risks. In fact, the historical odds of losing money are less than 2%. Moreover, they provide quick diversification and a much faster cash payout than other alternatives. And on top of that, you get to buy at a discount.

For these reasons secondaries consistently outperform their underlying private equity and venture capital investments. On our panel, there is Mike Pugatec from HarborVest. HarborVest basically invented the secondaries category in the 1980s. It has about $100 billion in assets under management, and boasts median annual gross returns of 19 1/2% per year.

We also have Patrick Gerbrand. From portfolio advisors, portfolio advisors has about 27 billion in assets under management, and arguably has one of the most extensive databases in the business. This provides a clear information advantage leading to consistently top quartile returns at below average risk.

Last but not least, from across the pond. We have Patrick connect Lee from Aberdeen in the UK. Aberdeen has been around for a couple of 100 years, though Patrick hasn't been around for all that time. He is widely viewed as one of the smartest players in the European theater with a track record to back it up. What all three have in common are exemplary track records, with returns consistently outperforming their peers, top quality management, and highly differentiated strategies providing sustainable competitive advantages. Enjoy. So let's begin with you know, a little bit of background. Mike, what are secondaries in your words? And importantly, why would our investors want them?

Mike Pugatch 2:48

Sure, thanks. Thanks, Joe. So secondaries and you touched on this a little bit, but simply put really just a byproduct of the of the primary market if you think about the primary fundraising market for private equity or alternatives. By definition, private equity is an illiquid asset class. And so the secondary market is really a means for investors in what is otherwise an illiquid asset class to be able to generate liquidity. Certainly investors typically go into private equity funds, with a long term horizon, not expecting to need to generate liquidity along the way, but there are reasons situations change for certain investors, whether there might be a rationale for seeking early liquidity from from those investments, you know, the secondary market today, and it's grown dramatically over the over the years really got it started in the mid 1980s, as you mentioned, today has grown to what was last year estimated to be north of $130 billion of annual deal volume within the secondary industry.

So, Limited Partnership stakes or GPS general partners, working with secondary buyers to move assets out of their portfolio into continuation fund transactions. So significant growth that we've seen over time in that in that market. And again, Sticking with the theme of sort of byproduct of the of the primary fundraising market, what are the statistics, if you look over the last five years, there's been $3 trillion of capital raised within the within the private equity industry and that is that is effectively the future inventory, if you will, that we think about within the within the secondary market for assets to be able to be able to purchase and so, you touched on some of the key reasons why, you know, secondaries would be interesting for for prospective investors, certainly buying into more mature assets. Companies and assets that are further partway through their investment periods, therefore closer to closer to liquidity.

Secondaries offer great opportunity to build diversified portfolios, particularly for newer investors into the asset class to be able to gain meaningful exposure to a large portion of the private equity market including that backwards looking diversification because we're typically buying, buying assets that have been around for for a number of years, get capital to work quickly get capital back more quickly. And then lastly, as you mentioned, it is also a lower risk strategy in terms of investing within the private equity markets.

Joseph Abramson 5:17

Okay, now on to you, Patrick G. Let's get to the question on everybody's mind. How are we going to make money in 2022? Or at least how do we keep from losing money? What are the key strategies?

Patrick Gerbracht 5:33

Yeah, that's a great question. I think, in the development of the private equity universe, there's, some managers are better than other managers. And I think our whole business model at Portfolio advisors is to align our secondary interests with the best managers in the world that have seen market cycles that have lived through COVID lived through the Great financial crisis lived through the venture capital bubble popping in 2000. And it's a long duration, asset class, valuation multiples change over time, they expand and they, they come back down to earth, but what you're ultimately looking to do when you enter the private equity world, and trusting these managers to drive value is aligning your investment portfolio with top flight managers managing the best companies and driving revenue and earnings growth. And you do that for years into the future. Even if there is an interim impact on people's secondary portfolios or private equity portfolios as a whole, as valuations come down. If you drive the top line and bottom line for an extended hold period, that's going to drive return for you as an investor. So you know, it's not a short term asset class, you don't try to trade out of it. If the markets move down temporarily, historically speaking, secondaries was viewed as a counter cyclical asset class. And so when times are distressed or higher, when people are in need of cash, that's classically one of the best times to invest in secondaries, as discounts typically get out on you, and creates a really attractive time to build out a portfolio and secondary. So again, long duration asset class, the best managers have seen this before, all of us on the call here, I guess I can safely assume we've all seen this before. And you really want to be opportunistic as you continue to deploy capital.

Joseph Abramson 7:19

And Patrick ., how about yourself, you know, what are kind of the key sectors or geographies or strategies that you're employing right now? It's, it's a pretty difficult market?

Patrick Knechtli 7:32

Yeah, that's right. It is. And I think, you know, we are seeing a little bit of a while not necessarily a hiatus, but there's a bit of a pause in the secondaries market, as we get these periods of dislocation, as valuations come off, you know, historic highs last year, it takes a little while, given the private equity reporting cycle on a quarterly basis for that to kind of work through the system.

But as Patrick G. was saying, you know, we're in a similar position, we favor top quality managers, top quality assets. You know, that's, that's kind of what we like to gain exposure to. And right now, you know, that is good downside protection, as well is investing in, in good quality assets, good quality managers, who can navigate through some of the difficulties that are coming up. You know, during COVID, another period of dislocation, we were very heavily focused on healthcare and tech businesses, you know, those areas of the economy that we didn't see as being so badly affected, or even being helped by by the sort of global health crisis. And that worked really well. I think, you know, again, sort of Patrick touched on this, but secondaries do tend to do well, in a time of dislocation. And I think for us, again, you know, that what this means is over, over the last few years, the secondary market has developed usually from, say, 20 years ago, when I first started, it was many banks selling and high net worth selling into the secondary market. We were saying at that time, you know, eventually pension funds will use the secondary market to manage their portfolios, manage risk, rebalance their portfolios, that's what they've been doing for the last 10 years. That's what they will continue to do. And in a period of dislocation, you know, interest rates, capital market changes as as they are right now. They have to rebalance their portfolios. And so, you know, we are expecting good opportunities to come through in that space, as well as all the new areas innovation secretary has been extremely good at innovating.

Mike mentioned the sort of GP led space. I mean, that's been a remarkable area of of innovation in the market over the last couple of years. So, you know, there will We flow from the sort of rebalancing of the market. But again, you know what, what we're focused on is good quality assets, good quality managers, where people are under a bit of pressure to sell. And hopefully we get those good discounts that you mentioned earlier on.

Joseph Abramson 10:13

Well, as Warren Buffett famously said, you know, be greedy when others are fearful and be fearful when others are greedy. And certainly, there's no shortage of fear out there right now. And possibly, as the year unfolds, maybe there'll be some some forced sellers, and the three of your firm's and secondaries in general, can take advantage of that. And in particular, that's one of the reasons why Northland likes them in this environment is, as people said, you can take advantage of dislocations of it. What are you seeing out there right now, Mike, and what strategies are you employing? And maybe a quick word on discounts? Are they are they widening? Are they back to their historical average? So yeah, what are you doing right now?

Mike Pugatch 11:14

Yeah, sure. So maybe first on the on the discount or pricing question. And the way you do you typically see in in periods of market volatility, such as what we're in now is a widening out of those discounts or an increase in discounts. We're certainly seeing that play out real time in the market today. Part of that if part of that is the overall market pullbacks and uncertainty in the environment, and part part of it, frankly, is if you think about private equity valuations, those portfolios are only revalued on a quarterly basis. And so we have, you know, at this point, the last, you know, two plus months of what's going on in the macro environment, what's going on in the public markets that hasn't yet flown through to the latest private market valuations which are as of as of the end of q1. And so that that creates a little bit of a, you know, sort of optics that also come into play, if you will, around those pricing dynamics and with the expectation that there may be a bit of softness flowing through private market valuations as we get into the q2 marks in light of the public market pullbacks that that exacerbates, I would say the widening out of those of those discounts. But certainly we are seeing that in the market today.

I mean, Patrick touched on this earlier in terms of I would say, you know, maybe a little bit of a pause in terms of market activity, some of that is around just bid ask spreads, frankly, widening out in light of those discounts that are better increasing, there are certainly still sellers that for for other, you know, non economic reasons need to divest need to need to sell at a particular moment in time. I think others may may wait may take a little bit of a pause in the market for the next, you know, several weeks, the next month or two before deciding to sell a portfolio but but certainly the pent up demand, if you will, or backlog around market opportunities is there and to transition to the first part of your question. It's there both on the on the GP lead side of the market and and with respect to LP interest. And so maybe for some on the LP side, we are seeing pressures that the institutional investors who may have been bumping up against their private equity allocation caps internally that are starting to breach those caps or run right up against those, those self imposed limitations that that will require a need to rebalance their portfolio sell down some private equity that may be in a traditional regular way sale. One of the things that at HarborVest we find very attractive in these market environments is opportunities to create bespoke structured liquidity solutions with large holders of private equity fund positions, essentially think a joint venture type transaction to allow a Counterparty a seller to transfer exposure off of its balance sheet into a newly formed vehicle that harbor best would invest in, provide some of that initial liquidity and then be invested and share cash flows and distributions coming off the portfolio sometimes in a differentiated way, on a go forward basis.

So that's certainly a key theme in the LP market. And then on the GP lead side, and I'm sure we'll talk more about this as we as we go out in the conversation but but no shortage of opportunities with general partners who are looking at, frankly, some of the uncertainty in the current environment, an IPO window that is largely closed today. And they look at opportunities to partner with secondary buyers to move some of their best performing assets into a newly formed continuation fund, create an exit event and create a an opportunity for liquidity for their existing investors in their funds, but continue to retain exposure to what they view as some of their most attractive portfolio companies on a go forward basis in partnership with a with a secondary buyer. So think about it as sort of a an equity recapitalisation, if you will of their exposure. because you're in certain portfolio companies by providing liquidity to existing LPs and provide a very attractive investment opportunities to secondary buyers.

Joseph Abramson 15:10

I know for me, I always had a long short hedge fund during the bursting of the tech bubble 2000 to 2003. And I have to tell you, the current environment is extremely reminiscent whether it's, you know, the valuation, whether it's the concentration in public markets going into this the exuberance, the amount of capital, flowing, the number of non profitable companies. So what kind of similarities and differences do you see from that bursting of the bubble in 2000 2003? And how does that affect your purchase of secondaries in venture capital funds versus private equity funds? Maybe we'll start with you, Patrick G.

Patrick Gerbracht 16:09

Sure, I think there's definitely some similarities is the compression of multiples. That is definitely, you know, echoes of other previous corrections that we've all experienced in our investing career, I think, when capital is cheap, I think a lot of companies lack discipline, it becomes a market share game of using funding rounds to go out and buy shares out in the market. And at some point, the music stops, and you're stuck. We're trying to figure out your business model, when you can't raise multiple, multiple 100 million dollar rounds, to be, you know, aggressive in the space. So I think, you know, as we look forward and look at opportunities today, what we're really looking for is efficient growth, companies that are very cashflow efficient, that have large amounts of cash on their balance sheet that actually can use this dislocation to their advantage, that if you have a cash runway of 280 months, which is literally one of the companies in a portfolio, we took the mark took to our investment committee in the last few weeks, you can use that to go out and acquire some of your competitors that maybe don't have the cash flow profile and the money saved up that you do. And so, you know, for us, we use that to our advantage that the bar, I'm sure for all of us on this call right now is really high. And we reject, you know, 98% of what we see. And even if prices gap out, there's times when it's not going to be a large enough discount to take on the risk reward in the portfolio.

But there's also in times like this market irrationality When sellers just want to get out of growth or get out of venture. And then if you do your homework and do your proper valuation work and have calls with the general partner and understand the portfolio of companies, you can find opportunities where the discounts are large enough where the risk reward really make sense. And you're looking at reasonable downside scenarios. And we all need to be thinking about downside scenarios if multiples compress more, how's that gonna impact the portfolio's you're evaluating, but I think, compared to the, you know, 2000–2002 Venture crash, where a lot of companies were really early in their growth, and it was more of an idea than a legitimate company. The fact that so many companies have been staying private longer before going IPO where they have 50, 100, 200 or 300 million of revenue, they might have you know, a couple 100 employees, they're way past the point of being a binary risks. And a lot of these companies have no debt on their balance sheet. And so even if growth drops from 60% to 45%, let's say for an example because they're trimming some investment in get out to market you know, approaches that still can be an attractive company if your whole periods long enough because if you're valuation multiple, you're buying it at as correlated to how far in the future you're buying revenue, you know, and or earnings. Eventually, you're still going to come out of that with a high value company or portfolio of companies that you can have the opportunity to buy. So again, get disciplines very important. The bar is very high for us, right now, portfolio advisors, but again, we're trying to be aggressive and spots where some people are exiting the market. Well, we'll go in if we have an information advantage.

Joseph Abramson 19:26

Very interesting. Very, very, very impressive. I think this idea of being disciplined and sticking to your you know, proven strategy makes a lot of sense. Because what you consistently see both in times of exuberance and turmoil is Many lose their heads. And so to be able to say, Oh, we're not gonna just, you know, shy away from tech, say, Yeah, you know, what the right price with the right company will not only, you know, be involved, but Those companies themselves can also take advantage of the of the turmoil. Mike, in two or three minutes, do you have anything to add to that? Basically, we're talking about similarities and differences versus the bursting of the tech bubble in 2000. And what that means for your venture capitalist strategy?

Mike Pugatch 20:21

Yeah, I mean, it was I think Patrick had a lot of good comments, I would agree with, you know, with with all of what he said, and certainly your opening comments, Joe, that there are a lot of similarities. I think there are also some, some differences as well. Right. And certainly the, you know, the the market environment we saw in the in the .com.

But during that period of time and subsequent recession was was largely a tech driven valuation driven event in the in the markets and, you know, other factors that led to led to a recession following that, you know, the current environment we're seeing is different insofar as we're seeing the valuation multiple pullback across across all sectors, we're seeing, you know, rising interest rates, we're seeing inflation that we haven't seen in long periods of time, that I think will lead to different, different challenges for businesses, not not just on the on the tech venture and growth side of the equation, but but sort of across the board and across across other industries. And that's certainly something that, you know, all of us are mindful of as we're as we're looking at opportunities, as we're vetting new, new transactions, performing diligence on on specific underlying underlying companies, and particularly, particularly around that inflationary environment that we are in now as well.

And, and I think that impacts again, all sectors, including tech, including those on the VC side, certainly there's a lot of discussion around the, you know, the war for talent. For instance, you hear that as a recurring theme for lots of venture managers right now, with respect to their underlying portfolio companies, you know, recruiting of software engineers, and developers, you know, sales, salespeople, etc. Where, you know, they're the sort of tight labor market that we're in right now provides further I think, challenges around both cost structure of existing businesses, but also the ability to continue to, to grow, where I think it does come down to ultimately, you know, being able to partner with best in class GPS, as well as focus on really sort of top performing companies out there businesses that are really market leaders that are able to attract talented individuals as they look to continue to scale their teams and grow their underlying business opportunities. So that's a little more granular as we think about what are the most attractive opportunities in the market and how you focus from a diligence perspective. But but certainly some differences I would I would highlight relative to where we were, you know, 20 years or so ago, on the back of, bubble burst.

But one of the same, the one of the similarities, though, of course, is and we've alluded to this a couple of times, uncertainty and volatility from a macro perspective does does create opportunities, and sometimes it takes a little bit of time for that to come through in terms of identifying those opportunities, and, and where those will ultimately lead to attractive investments. But certainly, as we look forward over the next couple of quarters, even over the next couple of years, some really interesting dynamics that we think set setup well, from a secondary investment perspective.

Joseph Abramson 23:23

Yeah, absolutely. And you raise an interesting point, Mike, and and maybe we can have Patrick, speak to it that, you know, if we look at the 2000s, two dozen, three, the macro draft backdrop was very deflationary. And we were seeing falling rates, which intermediate term ended up supporting valuations. You know, Patrick, what do you see as the impact of this more inflationary environment where we have rising interest rates? So most private equity, not as much venture capital, but most private equity and many secondary funds? Employ leverage? So So what do you see as the impact of rising inflation and interest rates on the underlying PE investments, and secondary as well?

Patrick Knechtli 24:23

Yeah, this is a pretty big topic, right. And we're trying to, we're trying to sort of fork through all of the different aspects of that. I think, you know, when we speak to our managers for the private equity managers who are day to day on the boards of these businesses, managing managing these businesses, you know, fortunately, a lot of them have focused their firepower on resilient businesses that have pricing power, that are able to pass on cost inflation that coming through the system, you know, so for example, you know those? Well, I suppose it's a difference from maybe 20 years ago, actually, that a lot of the private equity managers are less generalist and much more sort of deeply integrated into their sectors and sub sectors where they have proper operational expertise in in managing the situation, so to say, you know, pricing power, and, you know, kind of adapting the different models or the businesses that they're invested in over time. So I think I think that's probably, you know, the first point, clearly, there's an impact on valuation, which, you know, we're seeing most acutely in the, in the tech space. And, in particular, in the sort of non profitable businesses.

Again, you know, we think, as the other guys have said, you know, there's, it's been a huge change over the last 20 years in terms of software, for example, it's just grown to something enormous, you know, what does the software's eating the world? And, you know, there's a lot of resilient businesses out there recurring revenues, you know, mission critical software, that will still prove, you know, to be very strong businesses to invest in to have exposure to the question is, where does the valuation of those businesses end up? And, you know, we are seeing that those four boring Tech was more resilient tech businesses, software businesses, you know, have have held up much better than than the more sort of cash burning unprofitable businesses that the likes of, you know, the really big investors like Softbank and Tiger global, were investing in, you know, pouring money into So, you know, I think is trying to fork through all of those different, you know, aspects that the sort of noise of the, the overall market and figure out, you know, kind of where is the best, best places to play, but that is, again, the beauty of secondaries is, is that you can touch and feel the assets and figure out, you know, what's the current valuation? Is it over? Is it over? Is it overvalued right now? Is it fairly valued? And then we apply, you know, whatever, discount or, you know, price we feel is appropriate for that.

You know, if there are if there is a large amount of leverage in the system, you know, as we sort of arrived at the global financial crisis, you know, that was a crisis that was a lot around, you know, over leveraged businesses. So it's actually being able to look through to the underlying companies, you know, what are the covenants looked like, which are the ones that are at risk of default? Again, you know, managers have learned their lessons from the global financial crisis. Generally, you know, there's a lot of covellite leverage packages in these businesses. So they're, they, you know, we have a reasonable degree of confidence that the managers were invested with, should be able to navigate through this. And they did, you know, they actually did an extremely good job during the financial crisis as well, given sort of the governance model of private equity, how they were able to renegotiate some of these highly levered situations. So. So yeah, you know, I think there's just, you sort of opened up a big topic there. I probably just touched on a couple of other aspects. But I don't know if my colleagues want to pitch in.

Joseph Abramson 28:30

Sure. Sure. So Mike, again, in just two or three minutes, what do you think, is the impact of rising rate? Environment? Let's really focus in on the leverage within secondary funds and the leverage in private equity funds. So obviously, the cost of capital is going up. Do you think that leverage decreases? Do you think it increases the distress so that you can buy more cheaply? What do you what do you see as the puts and takes?

Mike Pugatch 29:05

Yeah, so I mean, you you hit on, I think, in my mind, what are the two the two big impacts? Right, it's really, really about the cost of leverage in the in the system, if you will, and that's both at the portfolio company level, as well as with respect to secondary purchases, to the extent the secondary investors are utilizing leverage to support their acquisition of larger diversified portfolios. And so at the company level, it's really a question around around cash flow, right, higher interest costs, and do the businesses themselves have the ability to support those higher interest costs in in servicing their debt.

And so from a you know, from a new investment perspective, when you know, when when we're evaluating opportunities, obviously being focused extra focused on both capital structure of underlying companies as well as, you know, just their debt service ratios, cash flow, that's that's, you know, cash flow conversion off of off of you To offer underlying businesses all about is, is important and making sure that, you know, we're not stepping into a situation or buying access to, to companies that may have near term cash flow challenges in light of those rising, rising interest costs, you know, many companies and frankly, general partners, you know, knowing the environment that we were in, I mean, it's sort of no secret that we've ended up in a rising interest rate environment, I think there's been a lot has been done at the portfolio company level, to actually swap out some of that floating rate, leverage or interest cost anyway into into fixed rate. And so that will help to stem some of those rising interest rate pressures, at least with respect to the existing portfolio companies, but that is certainly a consideration.

And then on the on the secondary purchaser or buyer side, you know, certainly there are certain strategies, certain players in the secondary market who I would say are more aggressive users of leverage, I mean, from HarborVest perspective, we have, you know, for longtime users leveraging, I would say, more conservative, prudent way around certain secondary investment purchases. So I think the large diversified portfolios are where there's identified near term cash flows, and distributions coming off of a portfolio where we can take leverage against our purchase price, and, frankly, enhance the targeted equity returns on a transaction. I think those who employ a more conservative approach, you know, will not see a big change in terms of the, you know, the amount of leverage that's available in the system, to be able to take against certain transactions, but it may have an impact for those who have been more aggressive users of leverage historically, in terms of just availability of debt. And then obviously, about the higher interest costs will have an impact as well, in terms of just the deep the arbitrage, if you will, or the the spread between gross and net of leverage returns for secondary investors.

Joseph Abramson 31:57

A lot of people are calling for for recession. What do you think, will be the impact of recession on on the secondary market? And PE, in general, obviously, it has a negative impact for cash flow, but maybe it helps with some of the buying because sellers become more distressed. What do you see as the impact? And you know, maybe an example of something underlying so that we can, you know, look at things in detail. Yeah, I

Patrick Gerbracht 32:37

I think from our firm's perspective, we weren't expecting for this app at some point now, for years of valuation compression that we've been doing fundamental underwriting of how are the companies valued? How are they be valued at the time of exit, when all that exit happened, that we've always had a very conservative approach to do due to exit timing of when those companies would be sold, that I always joke with, with the individuals on our team that the last thing I want to do is buy a portfolio that we got approved because it was predicated on three value driving companies being sold in the first 12 months that we know a lot of things happen in real life, the GPs are tend to be very rosy and optimistic on their own portfolio. And so from a base case perspective, we often push back the the exits on companies years versus what the gap says. And so that's a built in hedge that if there's a recession, if the IPO window, remains largely closed at the m&a market slowdown, because debt is harder to set up for financing for those types of acquisitions, then we're okay, well, we don't have to go back and look at transactions that we closed on and say, Oh, well, we have this company exiting the summer of 2022. And it's the summer of 2024. It's still in there.

I think the recession will completely obviously factor into pricing. And I think secondaries an advantage for all of us, we always say advantage buyer, because you're getting off of a record date, that was three months, six months, nine months in the past. And that look back ability is very important if saying, okay, in the last half year since the record date, how are the companies performed since the record date? What are the public equity markets done? What's the larger macro environment and that factors directly into pricing, and I'm sure all of us on the call here, have had conversations with sellers have it's been a very interesting education process over the last few months is saying, Look, you know, this asset maybe when you launched the process, you were told that it would be sold at a 5% discount, but the world's changed now that discount is a 15 or 20% discount. And then you tie that in looking forward to understanding the general partners, how they mark their portfolios and how conservative or aggressive they are. And so as we wait for, you know, as year end financials have been coming out now, as March financials are released, and eventually June I think all of us are going to have a very acute eye on the marks on these portfolios and how much they're adjusted based off of what's going on in the NASDAQ and the s&p. And then all of us have to individually judge price of is the price that we're offering in August of this year or October this year, reflective of the risk in the portfolio, you know, all of us, on the call here have primary programs.

And I'm sure all of us use that set of relationships really to understand and have gained insight on the portfolios right now, because you really need to, you know, be able to see around corners, right now, you have to minimize surprises. You know, I joke that it's hard enough in the secondaries, business, they didn't have a primary program. And someone hands you a financial statement where you have no history with the manager, and they say we need a bid and five days, it's really hard to understand and underwrite risk. And so having that access to the general partners really is crucial for the job we're doing. And we're constantly tacking in our pricing based off of the company level, the fun level dynamics, and then the larger economy, and will adjust as more information comes to light as the Fed increases rates as expats expectations change. If a recession, it gets closer and closer to we see its negative GDP quarters, then that will be reflected in price. And that's why it's really attractive, and you let off the top on its, as a whole, we've really proved as an industry, it's hard to lose money in secondaries, and that looked back ability and the ability to bide assets at a discount to have a buffer and times of a crisis. And while things are moving, I think is crucial to preservation of capital that our industry has proven that we can do on top of the consistent returns, you're able to generate for investors.

Joseph Abramson 36:52

Very interesting, very interesting. And I was just wondering, Patrick Kay, maybe you can speak to what this means, you know, for for Europe, I mean, arguably, Europe's already in recession. So what do you see as the impact on on portfolios in the European Theater?

Patrick Knechtli 37:13

Well, in some ways, Europe didn't inflate quite as much as, as North America in terms of valuation. So you know, the recovery, for example, in COVID. Was, was extremely strong, much stronger in, in the US markets, for example, and it was in in Europe, if you just look at the sort of key indices. So in a way, there's probably less less far to fall in, in that sense. And, you know, we've been, you know, we, we're not a homogenous market, like in the US, obviously. So, you know, there's a bunch of different countries within Europe that are sort of traveling at different speeds. I mean, I sit in the UK, and we've had Brexit as well as an additional headwind to focus on but again, you know, I think that's where private equity businesses have been extremely good at adapting, you know, the way the governance model of, you know, the ownership of controlling stakes in these businesses. The ability to select the right businesses in the first place, you know, has has served private equity, existing portfolios, and their performance? Very well.

So, I think, you know, I think we've all mentioned during the course of this, you know, we depend on our job is forecasting our exits. And, you know, we've been through a fantastic period of time, where kind of all exit markets were open, you know, strategic buyers, financial buyers, IPO markets, a whole load of other sort of structured options for people to get money out of these otherwise illiquid portfolios, you know, IPOs are getting more difficult. We still are seeing, you know, some activity in that space in localized markets. In the Nordics, for example. It's been absolutely remarkable what, you know, relatively small businesses that have been able to list on the Norwegian exchange, for example. So it is a bit different to in the US for those sort of countries specific reasons. But, you know, clearly, that is becoming more challenging now that you know, that that IPO aspect,

Joseph Abramson 39:37

one of the things that you're you're hearing is the the leverage loan market in Europe, it has been effectively shut, it's still open in the US, just the cost of leverage is going up, but essentially shut in Europe. You know, is there an impact of this market in terms of the underlying private equity firms and and how does that impact your secondary funds?

Patrick Knechtli 40:10

Yeah, I mean, it affects the circulation of cash, obviously, and reduces, reduces the ability to exit to another financial buyer, for example. So it's a bit difficult to say whether that's just a sort of pause as people kind of readjust right now, or whether that's a sort of a more sort of medium term effect. But you're right. I think, you know, we are hearing that, anecdotally, that, particularly for the larger deals, I think, you know, at the sort of larger sort of large mega end of the sort of buyout space that there is a sort of some indigestion, shall we say, less so at the sort of smaller end of the market where, you know, we tend to focus, you know, our platform, on the primary side, as well as on what we're doing on secondaries is mainly sort of mid and low and mid market. And so kind of less impact and maybe, you know, other options in in terms of financing some of these businesses.

Joseph Abramson 41:14

And might, the SEC is discussing increased disclosure, from secondary funds. And in particular, one thing that they're mulling over is the requirement that there is a valuation opinion on all GP transactions. Now, as you and I both know, GP so general partner led transactions have been increasing market share. They're large, they're highly complex, which decreases the number of players that can be involved, which increases the potential returns. So in two or three minutes, can you speak to, you know, the likelihood of this requirement for a valuation opinion coming through? And what do you think will be the impact on the secondary market? Because of that?

Mike Pugatch 42:16

It's a good question. And, yeah, the SEC, certainly has been looking at these transactions closely over the last couple of years, we're really with, you know, having sort of investor best interest in mind and inherently with any of these GP led transactions, that the underlying general partner has any conflicted position about the seller from the existing fund. That's, that's creating a realization event. But they are they are the manager, and essentially, the buyer with respect to being the GP of the new continuation fund vehicle. And so for that reason, there is lots of disclosure that's required with their existing investors typically consents that they need to seek from their underlying advisory committees of their various funds, just given that the conflicted nature of that of that transaction. And so the SEC is looking closely at that one of the suggestions that has come out of it, as you alluded to, is requiring valuation with various opinions with respect to all of those transactions, I think that is being done with a subset of the transactions we see completed in the market already today.

I think for many large investors in existing funds are members of the limited partner advisory committees of those funds, they want assurances that there's a fair process that's being run on, you know, in connection with the sale of assets, and certainly, that the valuation has been, you know, third party validated, et cetera. And so I think there's a lot of momentum behind that, behind that request, or potential mandate from the SEC. In this in the spirit of, you know, transparency and fairness. I don't think fundamentally that changes anything from you know, from our perspective, in terms of just the growth and momentum in the GP LED market. I think it's extra belt and suspenders to give existing investors in those funds comfort that, you know, a price around a transaction is is fair.

But ultimately, the way general partners have typically been been running these transactions is to hire an advisory and an advisor or an intermediary to help with the process to help market check bids, when some sort of competitive process in any event, and so I do view this as an incremental step that's really about providing comfort to those existing existing investors, but but not fundamentally changing anything. In terms of the growth of that market. We've always been big advocates because of our primary business. And I know Patrick and Patrick would probably agree with this as well that you know, we preach to GPS that transparency in these deals is key and making sure that that existing LPs and sellers if you will have the same level of information that the prospective buyers do, because that is important to make sure that everyone feels included in the process everyone feels like they're being treated fairly. And I think this is just one step to, to further bolster them.

Joseph Abramson 45:06

Interesting. Interesting. And Patrick G. You know, there's 1000s of private equity funds and, you know, at least hundreds of secondary funds, you know, what makes your fund different? What, you know, what are the key benefits of portfolio advisors versus some of the competition, not not, you know, Aberdeen or harbor vest, you guys are all good, but, but in general, what sets you apart,

Patrick Gerbracht 45:36

these gentleman on the call that have great secondary programs, so I'd be utmost respect for them. And I think from when I'm on the fundraising trail, I tell a lot of groups, there's not one thing that makes us different. But I think if you stack up a number of our attributes, I think we have a compelling product in the market. I think all of us now and we're on the fundraising trail also, are stepping into situations where people are building out their secondaries manager roster. And so some groups have exposure to groups that really use leverage aggressively, you know, already is a big user of leverage in this space. And there's nothing wrong with that they have excellent returns. And we try to position ourselves as potentially being complimentary to a group that's on the top end of the spectrum that is really focusing on the billion dollar plus transactions, we view ourselves as a middle market secondaries manager. You know, the first off and the bottom line is returns.

I think our returns we're really proud of as an organization, we have consistent returns through different market cycles, I think it's really important to put the investor's mind at ease that it's not one fund is first quartile and another fund is fourth quartile. But we have been able to deliver consistent returns in the marketplace, we are very conservative in our use of leverage not to say never. But typically, we are not using third party transaction leverage at the time of purchase, what we really focus on is carving out managers we know well, from our primary business. And because market volume has increased to 140 billion, there's plenty of opportunities for us to carve out not just 25 $50 million opportunities, but often 100 200 400 $500 million opportunities for much larger portfolios. Our approach to fees, also we believe is differentiated in the marketplace, and our little loss ratios as well. So I think, you know, I spoke about the primary program, not everyone has it, I know on this call groups do and I think we all I don't speak for them, but we believe that's an advantage in the space.

So it's one way to clean the market. Another way to separate the market is a very large players from a medium sized players and the smaller players, there's different attributes in each of those kind of weight classes, if you will, of pros and cons, we like where we sit, and combine that with returns and fees, and then hopefully we can get traction for someone to take a look at us and our product.

Joseph Abramson 47:52

Fantastic. And Patrick Kay, you know, same same question. You know, what's, what's the value proposition? For Aberdeen? How do you create value for clients and underlying portfolio company,

Patrick Knechtli 48:07

We badger ourselves as focusing on on niche secondaries. You know, we recognize that there's a very competitive market out there. And we were trying to play to our strengths. So that that's really sort of focusing on areas of the market, where either there's sort of more complex structures that fit around high quality portfolios, where there are where we can play to the strengths of our primary platform.

So typically, in funds that don't come on the secondary market very often where the manager is restricted, because in in these transactions, you have to get the approval of the manager. And in some cases, particularly at the smaller end of the market, they can be quite sensitive about who the buyer is that comes into their fund. So that's helpful to us. And then on the more complex and in this sort of GP lead space. Again, you know, when we're a small fund, you know, we're not able to lead on a on a large GP lead, you know, sometimes we sit alongside these guys alongside portfolio advisors, or HarborVest on a deal.

But, you know, that will be sort of more in the syndication phase. But we do like to lead on the smaller, more complex transactions where, generally, generally speaking, the smaller secondary guys maybe don't have the expertise, they don't have the corporate finance skills, you know, these are complex transactions to to get involved in. But again, you know, we're playing to the strengths of our existing primary relationships with managers, the existing insights we have into assets as far as possible, you know, for us that that's the filter for the deal.

You know, we're all seeing huge amounts of deal flow coming in. The first thing that really decides whether we work on a deal or not is, you know, do we know the situation well, what other experience and insights can we bring to bear to help us win the deal? And underwrite, underwrite the assets. So. So yeah, I think its focus is identifying what we see as those sort of niche areas where there's less competition, ultimately, that leads to buying better pricing and securing those better returns.

Joseph Abramson 50:17

Mike, how about you? What would you say is the sustainable competitive advantage of harbor vest? Yeah, so

Mike Pugatch 50:24

So for us, you know, we really think about a couple of things, man it gets. It's the experience of our team. And we've been investing in secondaries for 35 years across the platform, a team that's been together for a long time now, very stable team investing together through multiple cycles. You know, fundamentally, I think, for us, in addition to data, and I think it's, you know, the size and scale of our, of our secondary business, we think that's important to be able to access all opportunities available in the market really be selective around which opportunities we choose to, to pursue, and there are very few competitors at the larger end of the market that can provide complete solutions and play at scale, particularly around many of these GP led transactions that are increasing in size. And being you being able to provide a large scale solution in that context, we think is a is an important differentiator.

And then I would also say just the platform relationships that we have across the firm. And so given our 40 plus year history, as a, as an organization, we have, you know, decades long relationships with general partners, you know, that that is helpful in terms of driving deal flow, it's helpful in terms of information advantages. As a firm, we actually sit on over 900 advisory boards of private equity, funds around the globe to an incredible amount of just information and access to relationships are close to 200 investment professionals, globally, that sit across all of our investment teams that are interfacing everyday with general partners with institutional investors all just sort of drive opportunities and help with the analysis of transactions. And we think that's an important differentiator for us.

Joseph Abramson 52:06

That's a That's fantastic. And, you know, all three of your firms are extremely impressive. And definitely, this conversation, you know, has been very, you know, useful and, and thought provoking. So, just to kind of, to wrap up, you know, what I'd like to say is, you know, the reason why at Northland, you know, we like secondaries, is because historically they've had superior returns, in fact, you know, the best in the investment world, but also, you know, lower risk, you know, under 2% chance of losing money, historically.

And in particular, in the current environment, where we're seeing increasing market dislocations, where there's the potential for recession, where volatility will either stay high or is likely to increase, you know, as the year progresses, and growth deteriorates, that secondaries have historically outperformed in that environment, and can take advantage of those market dislocations because they're buying at a discount because they have liquidity when others do not. So once again, I'd like to thank our participants, and if any of our viewers have follow up questions, feel free to contact your Northland representative. Thank you and have a wonderful day.


secondaries, portfolio, market, private equity, businesses, funds, companies, managers, investors, returns, leverage, secondary market, buying, valuation, underlying, opportunities, assets,


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