New York/Miami/Bad Homburg/Singapore/Hong Kong, June 13, 2024
The HQ Capital Group (“HQC Auda”), a leading global private equity specialist since 1989, announced the final closing of its latest co-investment fund Auda Co-Investment Fund III (“ACF III” or the “Fund”) at a hard cap of $255,000,000. The limited partners in ACF III consist of institutional investors including pension funds, insurance companies, and foundations as well as family offices and HNWIs. The global investor base includes partners from Europe, North America, South America, the Middle East, and Asia.

Marc Brugger, CEO & CFO of HQC Auda, said: “Our co-investment program offers unique access to direct investments alongside our quality network of GPs. We thank our investors for their support and confidence in our strategy and team.”

Marc Lohser, Global Head of Co-Investments and Portfolio Manager of ACF III, added: “Auda Co-Investment Fund III will continue our highly successful co-investment series and build on the strong performance of our prior funds. Our investors appreciate that we have remained focused on the small and mid-market and sized ACF III appropriately to source and execute on deals in this space. We are grateful for the strong support from existing and new investors who recognize our differentiated approach and look forward to continuing to deliver market leading returns for our clients.”

ACF III will build a portfolio consisting of 35 to 40 companies primarily in North America and Europe that are diversified by sector, strategy, and general partner. HQC Auda will leverage its extensive GP network to identify the best opportunities available in the market and maintain a focus on portfolio construction. HQC Auda has completed over 90 co-investments since 2015 and has become a preferred co-investment partner for small and mid-market GPs.

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Podcast Episode mit Britta Lindhorst

The post The rise of GP-led secondaries appeared first on HQ Capital.

Insights: Ben, what do you see as driving growth in secondaries?

Ben: I see it as a function of three things. First is the overall growth of private equity AUM. As pri-vate equity volume grows, in the form of primary commitments, so does the potential for second-aries down the line. Second is the uptick in current secondary products available. When I started in secondaries in 2008 there was a little bit of a stigma around LPs selling their interests, whereas to-day it is commonplace. The third thing is innovation within secondaries. The GP-Led space, for in-stance, has grown to become a much larger part of the market in recent years as well as preferred equity deals.

Insights: And do you see a correlation between the growth of fundraising and the rise of secondaries?

Ben: Definitely. We have seen about 10% growth in fundraising in private equity year-over-year in the last decade. Every time new dollars are raised, that becomes a possible secondary deal.

Insights: That means your potential for secondaries increases also about 10% year-over-year?

Ben: Right. If you think about secondary market volume as a percent of overall private market AUM, it oscillates between ~0.6% and ~1.2% over the last decade. There is no reason it has to re-main at this level. As more innovative products inevitably appear, secondaries volume will increase even more. The main takeaway is that while people pay attention to the increase in transactions and number of secondaries buyers, I think what often gets lost is that the supply still outweighs the demand. This creates an imbalance and, as a buyer, this means the wind is at your back.

Insights: How big do you think the secondary market will become in the next five to ten years?

Ben: If you just consider that you have 10% growth in private market AUM over the next ten years, and the percent of secondary market volume is ~1.0% of that AUM, you are tripling your volume in ten years which would be ~$300 billion based on 2021 estimates. However, it is likely to be even greater than that, and there are predictions that are much larger, because as secondaries continue to become more accepted, we expect turnover to increase. Of course, there are a lot of different ways it could go but the likelihood is that it will continue to increase substantially over the next decade.

Insights: Why is it attractive for investors to increase their secondary allocation?

Ben: Secondaries can be a good place to start because you can put a lot of money to work immedi-ately, build a diversified portfolio quickly, and get your money turned around a bit quicker. Even if you are an existing investor in private equity, there is a lot of potential upside to adding secondar-ies to your portfolio. Say you are a Family Office with a strong private equity allocation already and you are getting back a lot of distributions right now. Allocating a portion of that to secondaries puts those distributions to work right away while avoiding the J-curve that occurs with new funds. On top of that, many times you are getting in at a pretty good discount to the valuation of what the assets are actually worth.

Insights: What is the profile of the sellers you are seeing in the market? Why are they selling?

Ben: The percentage of sellers that are sovereign wealth funds, asset managers, public pensions, etc. changes a lot from year to year and the classifications shift depending on who is categorizing them (e.g., one group’s Family Office is another’s Fund of Fund) so I do not think it is a productive exercise to try and identify trends based on that. One trend that is undeniable though is the GP as a seller. GP-Led deals have really become a large part of the market and it is continuing to increase. In 2016 the GP as a seller made up less than a quarter of overall volume but has grown to an esti-mated 60% as of the first half of 2021. Whether that volume will continue is debatable but the one easy takeaway here is that the GP as a seller is becoming a very significant part of the market.

Insights: Why do you think GPs have become such a big part of the market?

Ben: This has a lot to do with the way funds are structured; typically, a ten-year term plus two one-year extensions. The reality is that holding periods are usually six to eight years (at least the target holding periods). This presents a problem for managers because they may be holding well-performing assets that they don’t want to sell either because there is not a suitable alternative as-set in which to reinvest the money or because it may not be in the best interest of their investors to sell without completing the value creation plan. What they can do instead is take these assets, sometimes it is a single company and sometimes several, and move them into what is called a con-tinuation vehicle which gives the LPs in the fund a way to continue to hold a position in these un-derlying companies or to get liquidity and exit the fund. This allows the GP to address the different needs of their LPs in the current fund and gives them the ability to stick with investments that they really like beyond the traditional investment period.

Insights: Do you see buyers migrating towards deals with certain characteristics?

Ben: Yes, but they are not migrating towards the same ones. Buyers are specializing, and this has been happening for several years. When I first got involved in secondaries, everyone was doing the same thing, and you had to because the volume of secondaries was such that you could not really specialize by industry or stage. All you would do was look at the assets and try and price them ap-propriately.

Insights: How has this changed over the years?

Ben: As transaction volume has increased, and as the supply continues to outweigh the demand, buyers have been able to develop their own advantages or specializations. For instance, HQ Capital has decades-long relationships with top-tier managers from its primary platform and leverages those relationships to buy high-quality assets. There are other managers that have strategies based on the idea that everything has a price, or that older funds tend to be underpriced by the market, or, increasingly, that they have insight into particular types of companies or industries. (It is still difficult to concentrate on specific industries but there are some groups that are looking more at tech or healthcare focused secondaries.) I think that trend will continue but I also think that it will be more important every year for secondaries buyers to determine where their outsized compe-tence is, where they have an advantage and operate within those boundaries.

Insights: You mentioned the trend towards GP-Led deals. Has anything in the GP-Led part of the market caught your attention recently?

Ben: Within GP-Led deals you can have a portfolio of assets, or you can have a single asset. I think what has caught everyone’s attention is the growth of single assets within GP-Leds, estimated at about half of all GP-Led deal volume. Many times, GP-Leds involve investment banks that are more accustomed to think about single company deals. Further, from an execution perspective, it is easi-er to execute single company deals than multiple company portfolios. Overall, I think single com-pany deals will be a very big part of the GP-Led market, but we are starting to see GP-Led portfolios come back a bit.

Insights: Pricing for buyout assets increased in 2021 over 2020 levels. What have you seen in the assets you are looking at?

Ben: In the business overall, and in our own pipeline, pricing has remained very stable. There are more investors today than there were five years ago, but if you look at pricing, it is actually about the same. Pricing for all strategies was about 92% of NAV in 2014, and in the first half of 2021 it was about 90% of NAV. During that period, pricing oscillated between the high-eighties and low nine-ties. Buyout pricing is usually higher by about 3-5% points. In 2014 it was 96%, the same as the first half of 2021. So, overall, we are not seeing a trend of higher pricing. If you compare pricing on a apples-to-apples basis today versus pre-2014 activity, it will show an increase but, overall, it has been really stable despite the increased transaction volume, particularly since the end of the GFC/Volker Rule/Basel III driven time period.

Insights: Where is your focus today?

Ben: Whether we are in up markets, down markets, or in-between, our focus is always on buying high-quality assets. In general, what we want to see is company top-line growth rates that are steady year-over-year, and healthy EBITDA margins. We focus mostly on buyout and growth assets so there are not a lot of companies that are not profitable on an EBITDA basis. And we generally do not want onerous leverage levels but, we know that compared to the public market, leverage levels are going to be higher for buyout and growth assets. We still conduct a bottom-up analysis on all of the deals in which we invest, and diversification is important.

Insights: And how can you get access to these high-quality assets?

Ben: The edge we bring to many of our secondaries is the relationships we have with managers, particularly restrictive ones who will not approve an investment to every buyer. Having invested with certain managers over ten and 20-year periods across multiple funds makes them more com-fortable with us becoming an LP than a secondary group that they don’t really know or who has not been supportive of them. And that is how we build our portfolios over time – through disciplined pricing with these types of assets and these types of managers.

Important disclaimers and performance disclosures
All data and information as of June 2021 unless otherwise noted. Based on HQ Capital research and analysis and the following sources: Jefferies Global Secondary Market Review (July 2021) and legacy Greenhill Cogent Global Secondary Market Reviews; Preqin. This document does not constitute an offer to sell, or a solicitation of an offer to buy, any security and may not be relied upon in connection with the purchase or sale of any security. HQ Capital prohibits any redistribution of this document without the prior written consent of HQ Capital. The document is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use is contrary to law, rule or regulation. HQ Capital makes no guarantee of future outcomes and/or targets. Past performance is not necessarily indicative of future results. Any projections and forecasts contained in this document are based on a variety of estimates and assumptions. There can be no assurance that the assumptions made in connection with the projections and forecasts will prove accurate, and actual results may differ materially. Opinions expressed are current opinions as of the date appearing in this material only. The information provided in these materials is illustrative and no assurance can be provided that any of the future events referenced herein (including projected or estimated returns or performance results) will occur on the terms contemplated herein or at all. While the data contained herein has been prepared from information that HQ Capital believes to be reliable, HQ Capital does not warrant the accuracy or completeness of such information.

The post The Evolving Secondary Market appeared first on HQ Capital.

Not all GP-led deals are alike
In today’s market landscape, most investors interested in secondaries funds have a grasp on the fundamental differences between Traditional secondaries and GP-led deals (hence, the commonness of the above question). However, one important and imbedded division within GP-led deals is often overlooked. When evaluating a GP-led transaction, there is a meaningful difference between the analysis required for a portfolio of companies (a “Portfolio CV”) versus a single company (a “Single Asset CV”). While alignment-of-interest considerations such as “cherry picking”, the economics of the CV’s, carry crystallization, GP investment, and new fund investment, apply to both Portfolio CVs and Single Asset CVs, the deal risks associated with imperfections in the alignment with the GP are magnified in Single Asset CVs due to the value concentration in one company.

Further, GP-led secondaries’ transaction volume continues to grow, particularly single company deals, whereby a GP can do one or more the following: (i) sell a majority stake of the asset to a CV that the GP continues to manage; (ii) sell a minority stake of the asset; or (iii) raise follow-on capital. The first two scenarios are often used to provide liquidity to investors whereas the third is used to support the company in its next stage of growth. Note that raising follow-on capital is also common in tandem with the first two scenarios for the same reason. In all three scenarios the deal is capitalized by new secondary investors.
New transaction types and the rise of Single Asset CV secondaries
While increased deal flow and the evolution of new transaction types are accretive for the secondary market overall, the rise of Single Asset CV secondaries has led many secondary firms to increase their risk appetite and company concentration limits to match the opportunities available in the market. In addition to the elevated concentration risk inherent in Single Asset CV deals, they can also lead to less liquidity. The expected hold period of most Single Asset CV secondaries is four to six years, often with limited or no interim distributions which results in a more restricted liquidity profile for the investment than secondaries investors are used to with Traditional deals.

Although we have found that in the majority of cases, GPs’ motivations for pursuing Single Asset CVs are in the best interests of their investors, secondaries funds must still be mindful of possible misalignment of interest during the due diligence process. Some of this comes down to the reason behind the sale, which can range from a company being the “crown jewel” of a maturing portfolio to the GP seeking liquidity after being in a broken sale process. Alignment-of-interest with the GP should always be front of mind during the deal-making process.
GP-led deals generally yield more bullish underwriting, in-line with the associated increase in concentration risk, compared to Traditional secondaries. Interpreting market surveys for deals completed in 2019 and 2020, underwriting for Traditional secondaries tended to be in the range of a 1.5x to 1.6x projected MOIC, whereas the projected MOIC for GP Portfolio CVs was ~1.8x and Single Asset CVs were in the range of 1.9x to 2.0x*.

The importance of a well-diversified portfolio
Single Asset CVs certainly represent an exciting and quickly growing area of the secondaries market. While we evaluate and occasionally invest in Single Asset CVs at HQ Capital, our principal efforts are focused on capturing the diversification and liquidity benefits offered by Traditional secondaries and GP Portfolio CVs, both of which form the bedrock of any investor’s secondaries portfolio. Further, HQ Capital’s integrated global platform and its long-term GP relationships, built over 30+ years of private equity investing, provide a unique vantage point from which to evaluate a GP’s track record, motivations, and alignment. These are the key factors used when assessing and executing secondary deals and we believe the HQ Capital platform grants us an advantage in the market. Above all, we remain focused on investing in high-quality assets and GPs, ensuring strong alignment-of-interest, while maintaining a disciplined investment strategy and adhering to self-imposed strict concentration limits.

Graph Source: Evercore (Secondary Market Survey Results, January 2021).

*Important disclaimers and performance disclosures
All data and information as of June 2021 unless otherwise noted. Based on HQ Capital analysis and research and the sources listed below:
Projected MOICs do not account for the secondary buyers’ economics.
Sources: Evercore (Secondary Market Survey Results, January 2021); Greenhill (Global Secondary Market Review, January 2021).
General: “High-Quality”: Any reference to the quality of a manager, fund, or asset is based on HQ Capital’s internal classification framework. A high-quality manager generally has a proven track record comprised of the following characteristics: demonstrable success in investing based on past performance, prudent portfolio company exits, an investor focus, underlying assets achieving growth and value creation, and secondary returns not dependent on upfront discounts to NAV. A high-quality fund or asset generally exhibits the following characteristics: returns driven by quality underlying assets exhibiting growth and value creation, not solely by headline discounts to NAV.
This document does not constitute an offer to sell, or a solicitation of an offer to buy, any security and may not be relied upon in connection with the purchase or sale of any security. HQ Capital prohibits any redistribution of this document without the prior written consent of HQ Capital. The document is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use is contrary to law, rule or regulation.
HQ Capital makes no guarantee of future outcomes and/or targets. Past performance is not necessarily indicative of future results. Any projections and forecasts contained in this document are based on a variety of estimates and assumptions. There can be no assurance that the assumptions made in connection with the projections and forecasts will prove accurate, and actual results may differ materially. Opinions expressed are current opinions as of the date appearing in this material only. The information provided in these materials is illustrative and no assurance can be provided that any of the future events referenced herein (including projected or estimated returns or performance results) will occur on the terms contemplated herein or at all. While the data contained herein has been prepared from information that HQ Capital believes to be reliable, HQ Capital does not warrant the accuracy or completeness of such information.

The post Portfolio Balance in Secondaries appeared first on HQ Capital.

As the year comes to an end, Insights reached out to HQ Capital’s Chairmen and Investment Committee members, Dr. Ernest Boles (Chairman U.S. & Europe) and David G. Pierce (Chairman Asia) to get their views on the state of the private equity market, including any trends they have noticed and potential opportunities on the horizon.

Ernest, David, let’s jump directly into 2020. COVID-19, a black swan or grey rhino event?

Boles: Definitely a grey rhino. Unlike a black swan, which is characterized by a fundamental lack of foreseeability, there have been discussions for years around the potential risks – economic and otherwise – of a global pandemic. A relatively recent example is Bill Gates who warned publicly about the risk and need to prepare in 2015. As perhaps the case with any grey rhino event, it is less a question of whether the event occurs, and more a question when and, importantly, assessing the potential severity of impact. There is clearly a long list of lessons learned.

Pierce: I agree. Not a black swan. As Gates said, when you think about risks and understand more about pandemics, it was clear that a new one would come along at some point. In fact, in Asia we experienced something similar with the SARS outbreak in 2003 and, at least in Hong Kong, the government has been pretty vigilant ever since. Fortunately, that disease did not spread so easily and the impact, in terms of adverse effects on overall public health and economic disruption, was far less than COVID-19. And, as I say, some lessons were learned then that helped this time.

To what extent did the pandemic affect your investment focus and philosophy?

Boles: There has been no fundamental change in our philosophy or approach, indeed, the HQ Capital private equity portfolio overall has proven to be quite resilient which I would attribute in large part to our
experience in identifying and allocating capital to high-quality managers with a proven ability to generate strong and consistent returns across cycles. The fact that our portfolio is well diversified is also critical
in managing exposure at the manager level and across industries.

Pierce: Yes, we have always sought to invest with teams that have the depth of experience and knowledge to understand exactly how to execute on their strategy and to identify where the opportunities and risks lie. Informed judgment, decisiveness, and the ability to act quickly are among the key attributes we look for in selecting general partners. In general, we have seen such managers react well to the impact of COVID-19 on their investee companies by, for example, helping management focus on maintaining liquidity until the effects on business became clearer, working out what changes may be required in plans, supply chains, and so on.

Has the COVID-19 experience sharpened our focus in certain areas of diligence?

Boles: In a certain way – yes. With respect to our co-investment portfolio, for example, it has become even more important to identify industries and sectors that will be more resilient to the pressures of a pandemic, supply chain disruption, shifts in consumer demand, and so on. As is the case in any dislocation or crisis, from an investment perspective, there will be industries that are more challenged and those that may even benefit from tailwinds. In short, while the current K-shaped recovery clearly has its challenges, it also offers a range of interesting investment opportunities.

Pierce: Agreed. As with other crises, this one has shown what prudent investors need to think about and do in order to manage risks and reap rewards.

Let’s turn to the markets. David, will the pandemic accelerate opportunities for private equity in the emerging markets of Asia?

Pierce: Across Asia, which is of course both vast and diverse, we expect the crisis will have an uneven impact in the near term. The pandemic has hit some countries much harder than others and this past year saw overall economic activity contract in India and Southeast Asia due to COVID-19. On the other hand, China, which is still classed by many as an emerging market, experienced modest growth in 2020. We expect the year ahead will continue to be challenging but growth will return to the emerging markets of the region, probably sooner than some expect.

But is it an accelerant for the emerging private equity industry in Asia?

Pierce: There are lots of reasons to believe that the opportunities for private equity in Asia will grow post-pandemic, especially in the countries and sectors we like. For example, we have been focused for some time on healthcare. COVID-19 has done nothing if not show how important it is both for that sector to develop and how private capital can supplement the resources of states. The demographic trends that have been fueling growth in Asia have not been halted by the pandemic. We are confident that private equity will continue to play a major and growing role in funding businesses that provide better quality healthcare, education, financial services and other goods and services demanded by the increasingly affluent people of the region.

Ernest, what is the state of private equity in the developed private equity markets?

Boles: The answer ultimately depends on the manager or specific investment, but the short answer is, in general, positively. Our existing portfolio – which includes primary and secondary fund investments as well as co-investments – provides a reasonably good barometer for the broader private equity market and has proven to be quite resilient to the events of 2020. This is based on various factors including our focus on small- and mid-market managers who have the flexibility to adapt to changing market conditions. At the same time, certain trends have continued in 2020 such as capital flows into a relatively small number of larger funds. The inability to travel during the pandemic has also resulted in limited partners sticking to managers they know which also will result in capital concentration in the largest GPs.

What is your performance outlook given this backdrop?

Boles: While many of these GPs have performed well historically, the question raised is whether they can effectively deploy these larger pools of capital, another reason for our preference for proven small- and mid-market GPs. In terms of our performance outlook, we believe the 2020 private equity vintage has outperformance potential which is a pattern we have experienced over our 30+ year history during other periods of crisis. While we can point to examples across our primary and secondary portfolios, a good example is evident in the strong performance exhibited in our co-investment strategy and program.

What sectors have continued to perform well?

Boles: The crisis has highlighted the resiliency of certain sectors, specifically those supported by long-term demographic and technological trends such as healthcare, business services, e-commerce, fintech, specialized industrial, and various areas within IT. The pandemic has also emphasized the divide between industries with sensitivity to the pressures inherent in lock-downs such as travel, hospitality, leisure, entertainment, food & beverage, and “brick and mortar” retail. It is no secret that e-commerce was redefining retail prior to the outbreak of the pandemic. Suffice it to say that the paradigm shift away from traditional retail to e-commerce has been further accelerated by the lockdowns.

What trends do you foresee for private equity in the near future?

Pierce: In Asia, we will see further growth and maturation of the industry. We expect to see increasing expertise and focus among general partners supported by a well-developed ecosystem of bankers, consultants and – most importantly – experienced local executives available and eager to join the management teams of private equity-backed companies. We will see more buyout funds, including in countries that previously had none, with more co-investment opportunities being made available to limited partners. We will see increasing emphasis on impact investing and sustainable development driven, in part, by the wishes of limited partners. And we will see the development of an increasingly robust secondaries market following, as elsewhere, the growth of the primary market.

Boles: An insight from 2020 has been the validation of certain existing trends and the relative attractiveness of certain industries which, in my view, draws a relatively clear roadmap for allocating capital looking forward. The good news is that we have strong existing relationships with GPs with the proven ability to generate returns in industries supported by these long-term demographic and technological trends including healthcare, business services, fintech, e-commerce, and specialized industrial. Another trend driven, in part, by the limited partner community is the evolution of ESG-based investment beyond traditional ESG or Sustainable Investing to “Impact Investing.” This is where ESG-factors become an integral part of the value creation strategy which can be measured in a quantifiable way with the objective of generating a
positive contribution to society and the environment. This will be a space to watch as increasingly more emphasis will be placed on the measurable positive impact of private equity’s investment activity.

Let’s end this with a prediction: 2021 will be a year of….

Boles: … of cautious optimism. 2020 might be remembered as a year of the near perfect storm with the pandemic hitting shore coincident with storms in various stages across the globe…strained global geopolitical relations, a controversial U.S. election year, and stalled Brexit negotiations with the clock ticking toward year end, just to name a few. As we round the corner into 2021, there is certainly improved visibility in terms of our ability to counter the pandemic, the drama of the U.S. election is in its final act, and the EU and the UK have signed a trade deal…Hallelujah! May the storm clouds clear and the sun emerge for more normalized conditions in 2021.

Pierce: I agree and would add that private equity investment historically does very well after economic crises. While we must always be attentive to risk and maintain our investment discipline, at the moment, I see no reason why that won’t be the case again this time.

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