Private Equity Q&A: Graham Douglas, Kline Hill Partners
The private equity secondaries industry enjoyed a healthy fundraising year in 2023 as investors set their sights on an abundance of supply at attractive prices. Greg Winterton spoke to Graham Douglas, Managing Director at secondaries investor, Kline Hill Partners, to get his thoughts on the current state of the space at the halfway mark of 2024.
GW: Graham, there was a lot of talk at the start of the year in secondaries circles that supply was outstripping the available dry powder in the space. Is that what you’re seeing, and if so, is supply coming mainly from LPs looking to rebalance and access liquidity, or from GPs raising continuation funds?
GD: Yes, we have seen a significant amount of supply in the market. It really ramped up in the second half of 2023 and continued into the start of 2024. Recently, many LPs have been looking to rebalance and, in some cases, generate liquidity to meet capital call requirements through secondaries in an environment that has seen M&A and IPO activity decline materially.
We have also seen fund-of-fund and secondary funds looking to sell positions with a focus of delivering distributions back to their investors. While the GP-led market volume has been below its peak in 2021, GP continuation funds still represented close to 50% of total secondary market transaction volume last year and are expected to continue to play a meaningful role going forward.
In terms of dry powder, it is estimated that the capital overhang (the ratio of dry powder to annual transaction volume) is around 2x, which means the secondary industry would run out of capital in two years if no one raised new capital, which is a fraction of the capital overhang seen in the buyout and venture spaces.
GW: Kline Hill operates more in the smaller end of the market. What are some of the trends that you have seen in this part of the market in the past 18 months or so?
GD: The smaller end of the market continues to be very active. Many smaller sellers are overallocated to private equity and are willing to sell high-quality assets at attractive discount levels in favor of generating liquidity. Even during times of broader macro stabilization and growth in the public market, as seen in the second half of 2023, secondary market volume is still very robust, similar to what we saw during the peak of the market in 2021 when secondary volumes also reached their all-time highs. We expect small-deal volume and secondary volumes to continue to be strong throughout the remainder of 2024.
GW: Kline Hill opened an office in Switzerland a couple of years ago. How has that gone for you so far?
GD: Having investment professionals who are local and close to many European managers and investors has been very helpful in terms of diligence and forming new relationships in new regions but we’ve also been able to leverage our international footprint to find new deal opportunities with many of the +4k European investors and +3.5k European general partners in the region.
GW: Are there any differences in secondaries deal activity in the US versus Europe? Is the European GP-led side less mature, for example?
GD: Secondary activity in Europe on the small end of the market has been consistent with what we have seen historically. Globally, European GP-led volume represented almost 30% of all GP-led volume, which is in line with European exposure within LP deals. In the small end of the GP-led market - transactions under $250m in size - we have seen similar volumes. We believe there is still a lot of opportunity as secondaries continue to grow in Europe.
GW: Lastly, Graham, a message to investors that haven’t yet added private equity secondaries exposure to their portfolios. What should they be asking during due diligence?
GD: I think LPs should understand a manager’s competitive advantage and what area they focus on for their transactions, including the age of the assets acquired, geographies and strategies. It’s also helpful to understand the sources of returns between discount, appreciation after close, and how much managers utilize debt to augment returns.
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Graham Douglas is a Managing Director at Kline Hill Partners
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