[BridgeWood]
My name is Bobby Wood, and I am the founding partner of BridgeWood Alternatives. BridgeWood is an alternative investment placement and advisory firm with a presence in both Hong Kong and the US. One of our core areas of focus is working with managers in Asia that we feel have a unique approach to their investment strategy along with a compelling and timely value proposition.
I am joined today by Frederic Azemard (Managing Partner) and Nathan Lee (Director) of TR Capital; one of the most active Secondary PE investors in Asia. TR’s strategy focuses on secondary directs and fund restructurings; $1bn AUM, 14-year track record, team of 25 located across 4 local offices in Asia.
Investors we speak to look at Asia for diversification, but also opportunities created by inefficiencies not found in their own backyards where there tends to be a tremendous amount of capital from very smart firms chasing the same opportunities. You have been focused on the secondaries markets in Asia for over 10 years now across 4 funds. Can you describe what the market looked like back then, and highlight how it has evolved?
[Frederic]
I can say that it has been a very exciting journey and the market has been growing and evolving at a relatively fast pace. If I look back between when we started and today, there have been two major changes.
The first one being the size of the market itself. The market was very small when we started in 2008. One of the reasons it was so small back then was because the key market in Asia was at its early stage. Investments made in 2004 were below $20bn in Asia and you still have GP’s active in the market. We were early, but we were also lucky with the global financial crisis, which generated quite a lot of motivated sellers and this is how we started TR capital. Now the market is around $15bn and growing at more than 30% YOY. That’s one of the main changes.
The second main change is the type of deal itself. When we started, the market was 100% passive secondaries, now it’s 50% passive and 50% active secondaries. What I mean by active secondaries is either secondary direct where we replace the seller on the cap table of the company or offer portfolio solutions where we acquire cherry picked companies to determine whether we may or may not continue to work with the selling GP. Both deals require direct investor approach and skillset, which is different to passive.
For us, we started doing LP secondary and moved quickly to active secondaries. There are a few reasons for that. The active strategy is more in line with our DNA, and has been working well for us so far. Secondly, it’s the fastest growing segment of the market; grew 2 times faster than the market last year. Thirdly, there are high-quality fast-growing companies in innovative sectors. The ones we like include digital, tech, digital consumer, and healthcare. More importantly, their prominence in Asia enables more influence and better control over liquidity events. The objective is to use these deal types to enter high quality, innovative, and fast growing companies with lower risk and shorter investment duration.
[BridgeWood]
What is the size of the Secondaries market today and what excites you most about the market dynamics?
[Nathan]
So as Frederic alluded to already, what really excites us about the space is that the market opportunity is larger and growing. On top of that, the competitive dynamics are not very intense.
If you look at global annual secondary volumes, these tend to be 1 to 1.5% of overall Private Equity AUM. Over half of that will be active secondaries. Most industry estimates point to the annual global secondary volumes being between $90bn and $135bn in the coming years. The transacted volumes of Asian secondaries have historically been between 6 to 10% of global volumes, so we estimate there to be between $5.5bn and $13.5bn of Asian secondaries transacted volumes per annum.
What is really driving the increase of this market opportunity, is the large exit in Asia right now. One number we keep track of is the number of unrealised assets held by funds, which are 6+ years older in Asia. At the end of 2018, that number was $250bn. At the end of 2020, that number has become $523bn. There are a large number of highly motivated sellers looking for liquidity in the market.
These are interesting dynamics for secondary investors. On top of that, we find that the competitive dynamics are not as intense in this part of the market
compared to the Asian market. What we found in the past 14 years is that we do active secondaries well, since local teams are able to do on-the-ground diligence, and investment professionals have direct investing backgrounds. If you look around at the competition, global secondaries funds are active in the region, but they look at Asia as a part of larger global portfolio. As such, they don’t have boots on the ground in Asia. Secondly, traditional secondary players do not have professionals with direct investing backgrounds. In active secondaries in Asia, if you look at $50mm plus deals, there are very few people who can lead and underwrite them. So that’s what excites us about the market today.
[BridgeWood]
I wanted to follow up on the point on exit overhangs that you brought up. Why do exits take longer in Asia?
[Nathan]
This is really a feature of the strategies within the Asian PE market. So, if you look at all of the transactive PE volume in Asia in 2020, a vast majority was VC and growth – with 60% in China and 80% in India. What you have is a lot of first-generation entrepreneurs who are backed by private equity firms. For them, the most natural exit route is an IPO. Now, what this also means is that because there is a large pool of potential candidates for IPO’s, it implicates longer paths for these IPOs in Asia. What we also found is this longer time for an exit route encourages buyouts; to sell to larger financial investors who are coming in at later rounds pre-IPO.
[BridgeWood]
Let’s switch gears talk about your experiences and views in the regions that you focus on. Starting with the elephant in the room – China. We have all read the negative headlines on China, how should investors navigate this market?
[Frederic]
We are a Pan-Asian fund. China is the largest private market, and also the largest part of our own portfolio – but we are not dogmatic. We will invest in the best opportunities in Asia. We are very aligned with our LP’s, and we ourselves are one of the largest investors in the fund.
Now, clearly there are issues in China today. There are geopolitical tensions between China and the US. You have slowdown in consumption – if you just take December 2020, the monthly retail sales growth YOY was only 1.7%, the lowest since August 2020. Certainly open to interpretation, but our read on the decision taken by the Chinese government was done with a focus on what it believes is good for the long-term development of the economy and good for the country for the next 10 to 20 years.
We are long-term investors. For us, this will create volatility in the short-term, but will be interesting in the long-term. China has large and interesting prospects, and is expected to be the largest economy in the world by 2030. They are innovative in nature, with the largest number of PhD students in the world – which will be twice as many as the US by 2025. The ‘Made in China 2025’ plans for China to become a global tech powerhouse with 10 industries high-tech targeted for world leadership. As of 2018, 25% of total employment was in digital economy compared to 12% in
2012.
As a private investor we like to take a longer view, we believe that right now timing is quite attractive as secondary investors. Valuations have come down. There will be potential challenges for a few Chinese firms to raise money so even more so than before, GP’s will need to generate DPI which makes them motivated sellers.
An increasing number of RMB GP’s are also looking to access USD LP’s and pools of capital. They are motivated to work with Secondary investors like us to build a US dollar track record through portfolio solution deals; we are the leader in the market and have struck several attractive RMB-to- USD deals.
We are confident with China but we should not ignore some of the short-term issues. India has been focusing quite a lot of attention since what happened in China last summer, and the growth is extremely interesting. There are large numbers of talented entrepreneurs, however, we need to remain a bit cautious because valuations are high while Covid seems to be almost behind. We need
to be patient to confirm that this is the case. The NIFTY Midcap 100 Index is up by over 40% from last 12 months.
Southeast Asia is early with lots of capital coming in, which means that the secondary market is growing and will continue to grow. Southeast Asia remains attractive for us and with opportunities increasing we are making some investments, both in terms of human capital and investment in companies. We have a positive view in the long-term for Southeast Asia.
[BridgeWood]
How should investors think of the Active Secondaries strategy vs. their primary market PE investments in Asia? Or perhaps, how should investors think about this strategy from a portfolio fit perspective within the context of a global private market investment program?
[Frederic]
Secondaries are now part of most investment programs with exposure to the best growth opportunities and an interesting risk return profile. The main question is really if you have long- term conviction on Asia. If you are positive on Asia, having Asian secondary exposure should probably be part of your mandate.
There are really two ways to do it. If you are large enough and have enough resources you would probably build your own team and access the market yourself, and it will probably be easier to do passive secondaries than active secondaries. Otherwise, having exposure in an Asian dedicated secondary fund makes sense.
You will also need to distinguish passive or active secondaries. Passive secondaries will probably give you more diversification, active secondaries less so but slightly better returns with target of 2x MOIC and 20% net IRR.
If you just started your Asia program, secondaries probably make even more sense as it gives you an interesting return as well as the ability to quickly become knowledgeable on the market.
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