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APAC’s untapped secondaries opportunity

The supply/demand imbalance in Asia-Pacific suggests significant growth potential in its secondaries market, say Bastian Wolff and Christian Keiber, co-founders of Aquilius Investment Partners

Q: What has private markets growth in Asia-Pacific looked like over the past few years

Bastian Wolff: Private markets have experienced transformational growth over the past two decades and are today an integral part of every institution- al investor’s portfolio. In Asia-Pacific, private markets assets under manage- ment have increased sevenfold over the past decade, according to data from Preqin, surpassing growth in other re- gions around the world. Preqin data also shows that Asia-Pacific now ac- counts for 30 percent of global AUM, making it the second-largest private capital market behind North America.

Christian Keiber: Despite holding such a large percentage of private mar- kets AUM, the amount of secondaries capital allocated to the region is lagging. We estimate less than 5 percent of global secondaries dry powder is allocated to Asia-Pacific, representing a significant supply/demand imbalance relative to the overall size of its private markets.

Q: What are the reasons for this lack of secondaries capital in Asia-Pacific?

CK: The APAC secondaries market is fundamentally complex and poses a far greater challenge to navigate than that of Europe and the US. First, it is largely disintermediated: the majority of secondaries transactions take place without a broker. This is very different from the US and Europe, where most deals are competitive processes run by large investment banks. Buyers of Asia- Pacific secondaries need to work from the ground up to source transactions, which is a time- and resource-inten- sive process. This requires a long-term commitment to the region – something many global players struggle with be- cause they can see better economies of scale in their home markets.

BW: The complexity of Asia-Pacific extends to the underwriting process, as information is less readily availa- ble. Closing information gaps requires more intensive effort compared with the desktop-orientated approach seen in other parts of the world. A bot- tom-up approach is crucial to fully un- derstand the assets and markets you are buying into. Here in APAC, you need to spend a lot more calories per dollar invested to be successful.

Q: What has been driving Asian secondaries dealflow this year?

BW: Rebalancing across institutional investors’ portfolios is a major driver of secondaries transactions today. Many investors are actively making decisions about where they want to invest their capital in the future, and there is a no- ticeable trend of investors redirecting their focus back to their home markets. This is because they understand these markets better and believe they offer better opportunities and safer returns. Such trends are highly supportive of transaction volumes.

CK: The last few years have been fraught with major fluctuations across the market. We went from a pandem- ic-induced standstill with few assets being sold, to an environment of high inflation, high interest rates and geo- political uncertainty. As a result, reali- sations have slowed down considerably because underlying assets are taking longer to sell, creating a mismatch be- tween distributions and forward com- mitments for LPs. This has and will continue to fuel the market, presenting a fertile breeding ground for attractive- ly priced secondaries transactions.

Q: Why is secondaries so

BW: There is a tendency to think about secondaries as a specific type of transac- tion, but the term actually encompasses a range of solutions that cater to the needs of private market participants.

We like to think of secondaries transac- tions as being a lubricant to help private markets operate more efficiently. They enable LPs to exit private market assets earlier than the typical 10-year fund life, and assist GPs in solving specific headaches or liquidity requirements across their portfolios. These products address a broad set of requirements and opportunities, and there is a real need for this toolkit in Asia.

CK: When you make a private market investment, it typically comes with a long-term investment horizon. Things can and do change along the way: LPs may have developed certain strategies five years ago, but these could have been altered since then. The same applies for GPs, who may have had certain business plans for assets when they were acquired that have evolved over time. Investment considerations change – this is especially true in the fast-moving and complex private mar- kets of APAC. As a provider of second- aries, it is important to help investors and managers address these changes through flexible, tailored liquidity solutions.

Q: Do GP-leds comprise a significant proportion of the APAC secondaries market?

CK: In the global context, GP-leds represent around half of the current secondaries market. Their growing prevalence in the US and Europe has created a positive feedback loop that is driving more activity in Asia-Pacific.

Although GP-leds comprise con- siderably less than half of the second- aries market in APAC, we expect this to change over time. These transac- tions are still considered new, so even though adoption is increasing, many GPs remain relatively unfamiliar with the nature of GP-leds. We believe it’s important to raise awareness in this market, and we spend a lot of time working proactively with GPs to take them through the pros and cons of GP- leds for their respective firms.

Q: What are Asia-Pacific GPs looking for from the secondaries market?

BW: GPs in Asia-Pacific grapple with many challenges and constraints in their existing funds, including a slow exit environment and differing needs from existing LPs. Some LPs wish to retain their investments, while others need liquidity – this requires custom- ised solutions from the secondaries market. However, there is currently a real lack of on-the-ground expertise and dedicated resources across the Asia-Pacific secondaries landscape. Very few have the capability to operate in the region.

There is also a genuine need for more secondaries capital to meet the wide range of investors’ needs. This capital should not only take the form of LP portfolio sales, but should also be available to support fund recapitalisa- tions, preferred equity capitalisations, GP spin-offs and other structured solu- tions. Currently, there is a lack of these comprehensive solutions available to Asia-Pacific GPs.

Q: What makes Asia-Pacific secondaries an attractive asset class for investors?

BW: Secondaries are a great way for in- vestors to gain exposure to the region at much lower risk. The asset class provides very diversified access to growth oppor- tunities in APAC through large pools of assets across different strategies, geogra- phies and sectors. Moreover, given the high level of pre-specification across sec- ondaries portfolios, you generally know what you are buying, which greatly min- imises blind-pool risk.

CK: The benefit of hindsight when investing in asset portfolios at a much later stage in their lifecycle contributes to an accelerated cashflow profile and faster distributions back to LPs. Sec- ondaries serve as a highly differentiat- ed way to invest that has historically achieved compelling long-term returns on a consistent basis.

Asia is gaining ground in secondaries

More investors and managers are considering secondaries as a solution for their portfolios, but the diverse nature of the region makes transactions more challenging, say Bastian Wolff, Christian Keiber, Anthony Wong and Jonathan Olier

The real estate secondaries market may not yet be so developed in AsiaPacific as in North America or Europe, but this fast-growing and evolving market means more investors and managers see it as a solution for their portfolio challenges. A less experienced manager and investor base and the complexities of a multi-jurisdictional region mean resourcing, technical expertise and lo- cal knowledge are crucial.

Bastian Wolff and Christian Keiber, founding partners of Asian secondaries specialist Aquilius Investment Partners, and Jonathan Olier and Anthony Wong, partners at law firm White & Case, share their thoughts on how the market is developing.

Q: The real estate secondaries market in Asia is tipped to grow. What is driving this from the investor side?

Bastian Wolff: There are several factors creating a growing volume of secondaries transactions in Asia. One is the denominator effect, in particular for US and UK investors. Sell-offs in bond and equity markets have left those investors over allocated to private markets.

Related to that is a general portfolio rebalancing across major LPs. In times of uncertainty, investors tend to gravitate towards their home markets, so LPs from the US and Europe are re- allocating away from Asia, which is far away for them.

Finally, there is a regulatory driver as insurance companies and banks are disposing of non-core real estate holdings to reduce risk-weighted assets.

Christian Keiber: There is also an opportunistic driver, which is the financial stress for some investors who have immediate liquidity constraints, although these opportunities are few and far be- tween and distress is rarely the reason a deal happens.

It usually tends to be a particular problem other than immediate liquidity that drives these transactions. In the vast majority of situations we come across, we are solving a very specific headache for an institution, rather than just a cash crunch.

Anthony Wong: These real estate funds tend to be closed-end and so have a fixed term, and a lot of the investors are underwriting with that fixed term in mind. This means that when these exits are not happening within the scheduled life of the fund, some of those investors need to find liquidity solutions because they have plans to redeploy that capital elsewhere. Obviously, they can stick around as well, but they do prefer to have as many options as possible.

Q: Why are GPs looking for fund recapitalizations and continuations in the region?

CK: The big driver is the lack of exit liquidity at the asset level for a lot of these GPs. During the pandemic, it was incredibly tough to exit and now higher rates and a very challenging debt market are making it difficult for buyers to finance asset acquisitions in a value-accretive way.

Even for the highest-quality assets, it is quite tough to divest these through a direct sales process in the current environment. So, GPs are looking for alternative ways to create liquidity.

Fund recaps and continuation funds allow GPs to proactively manage liquidity in an environment where there is essentially none. The reason the secondaries market is taking off in Asia is that it is a win-win, offering exit liquidity to LPs while allowing GPs to continue to drive value creation for these assets. For a secondary buyer like us, we come in as a problem solver, and in return, we are getting exposure to quality assets, managed by reputable GPs with a known track record.

Jonathan Olier: The secondaries mar- ket in Asia is still quite new compared with North America and Europe. As such it offers real opportunities for participants with the right sophistication and mindset, for both investors and managers alike. This trend reflects an increased sophistication of the Asian fund market even if not all Asia- based or Asia-focused GPs are yet familiar with executing complex recaps, GP buyouts or continuation funds, including the legal issues surrounding them.

The market is evolving and advisers like us are able to import deal technology and solutions from more sophisticated markets and apply it to Asia, taking into account the particularities of each market.

Q: What is behind the recent rise in ‘GP-led’ transactions in Asia? Will LP-led deals continue to grow as well?

BW: We are very confident about the growth of the market in Asia-Pacific. LP-leds are the bedrock of the secondaries market and will continue to churn 2-3 percent of the primary mar- ket every year.

For GP-leds, there is a substantial tail of unresolved NAV that needs to be liquidated in the coming years. When we are on the road meeting sponsors in this region, every one of them has at least one headache to solve currently in their portfolio.

That tells us that there is some real pent-up demand for GP-led solutions in Asia. The more GPs hear about the different solutions that secondaries transactions can provide to them, the more they are keen to explore them. Looking at our pipeline, there are several very complex opportunities including fund recaps, GP spinouts and situations that wouldn’t have been on the agenda in the past two or three years.

AW: There will still be plenty of demand for LP-led transactions too, for all the reasons we have talked about that make LPs motivated sellers. And from the perspective of a secondaries buyer, these transactions are very different in nature.

An LP-led deal can be executed relatively quickly. A recap is a longer and more complicated process, but gives a secondaries buyer more options in customizing the investment. There is appetite for both types.

“There is a real need for a [secondaries] product that not only addresses diversification from a global perspective, but also more regionally for the Asia-Pacific market”

BASTIAN WOLFF
Aquilius Investment Partners

Q: What are the complexities and challenges of the Asian real estate secondaries market?

CK: There are three broad areas of complexity. First, sourcing and deal generation because the market is highly disinter-mediated. On one hand, this is good for secondaries-focused funds such as us because this creates a breed- ing ground for very attractive deals for our LPs, on an off-market basis, but it also means you need to create these transactions yourself, through your network, and that is not always easy and is time-consuming.

Secondly, due diligence can be more challenging because there is less access to information. Without boots on the ground, it is much harder to get con- text on certain of the underlying assets and source the information required for the rigorous bottom-up underwriting that these transactions require.

because you are working on portfolios that cross geographies and jurisdictions, each with their own tax and legal structure. It is therefore critical to harness deep technical expertise both in-house and through external advisers.

JO: The legal side definitely adds complexity due to the number of different jurisdictions involved, especially in a world moving back towards increased restrictions on foreign ownership regulations. Foreign ownership can become a significant issue for structuring secondaries transactions as the LP base of the exiting fund will not be the same as for the acquiring or continuation fund. This analysis will need to be done for each jurisdiction in which underlying assets are located.

BW: That means secondaries transactions in Asia-Pacific require much more experience and resources than you would need to put to work in other parts of the world. We had to build out our team accordingly in order to meet these sourcing and execution challenges. That of course requires a significant investment, which not many global players are willing to make because they have economies of scale in their home markets.

Q: How is demand growing for Asian real estate secondaries as an investment product?

BW: We see a lot of demand, not least because of the diversification that secondaries can provide. You avoid concentration risk if you invest in a secondary portfolio because you will be broadly diversified across sectors, strategies, geographies, managers and fund vintages.

There is a real need for a product that not only addresses diversification from a global perspective, but also more regionally for the Asia-Pacific market, which frankly hasn’t really existed previously. On top of that, investors want the usual benefits of secondary strategies, such as investing at a margin of safety, typically investing at a discount to intrinsic value and avoiding a J-curve.

JO: There is also a counter-cyclical element to it for some investors who see secondaries in Asia as a way to benefit from the market cycle. Additionally, we are seeing certain large institutional investors, who traditionally would not allocate capital to secondaries strategies in Asia, seriously thinking about deploying capital in this industry in Asia. It becomes a virtuous cycle as more transactions and experience leads to more options and therefore more secondaries transactions.

“A recap is a longer and more complicated process, but gives a secondaries buyer more options in customizing the investment”

ANTHONY WONG
White & Case

Q: How much does the approach to GP-led secondaries vary around the region in Asia-Pacific?

BW: Generally, LPs in these funds tend to be sophisticated institutional investors from the US or Europe and are familiar with the concept of a GP-led transaction. However, not all regional GPs here in Asia have come across the full toolbox of solutions yet because the US has been blazing the trail over the past years and Asia is catching up. The market here is disinter-mediated. In the US or Europe, you have the brokers calling managers weekly and pitching to them, but that does not happen to the same extent in Asia-Pacific.

AW: When we speak to managers in Asia, most have heard of GP-led transactions as an idea, but not many of them have gone through the actual process themselves and executed on GP-led secondaries. The markets in Asia do not function homogeneously, and that includes how regulations work in different jurisdictions, both at the asset level as well as the manager level in terms of how things like conflicts of interest need to be approached. That regulatory element needs to be managed carefully, in addition to the commercial aspects of executing a GP-led transaction.

Aquilius Investment Partners, a real estate secondaries investor, is tracking significant, opportunistic private equity deal flow in the current exit malaise. Diversification is the theme of the maiden fund

When Singapore’s Aquilius Investment Partners set up shop in 2021, the founders wanted to address what they saw as a fundamental lack of dedicated secondary capital in Asia. It is perhaps telling that the firm didn’t finish raising its debut fund until that year’s investment boom had ended and the ensuing exit slowdown had come into focus.

The fund closed this month with USO 400m in commitments from a mix of sovereign wealth funds, endowments, and family offices. Aquilius declined to specify how long the fund was in the market but described it as a rapid fundraise driven by strong demand.

The founders’ credentials offered some comfort to LPs. Aquilius was established by Bastian Wolff, a 15-year veteran of Partners Group, and Christian Keiber, who spent nine years at The Blackstone Group. Wolff served as Partners Group’s head of private real estate in Asia, while Keiber was a managing director covering Southeast Asia and Australia private equity for Blackstone.

Part of the pitch to investors was Asian exposure uncoupled to a specific market or strategy. Keiber describes real estate as the preferred asset class but Aquilius is tracking significant deal flow in private equity, which is expected to represent about 20% of the portfolio.

“You always have investors who prefer certain geographies or asset classes over others, but this is exactly the beauty of this product- that we very consciously focus on diversification,” Keiber said, when asked if LPs had specified that they wanted to avoid China exposure.

“We want to make sure that the portfolio we construct doesn’t depend on a particular sector or a particular geography. If you have a long-term positive view on the region, this is a product that will resonate very well with you.”

Deal flow to date is said to span the gamut of transaction types, from traditional LP fund positions to GP-led and direct secondaries. Preferred equity or net asset value (NAV) financing arrangements – seen as effective in solving specific liquidity problems with upside potential and a minimal upfront haircut- are also part of the offering.

Wolff observes that GP-led deal flow is growing given the difficult exit environment, including complex fund recapitalisations, joint venture recaps, and continuation vehicles. But this is not outpacing traditional transactions. He estimates up to 70% of activity since the start of the year has been LP-led, driven by investors altering regional allocations and addressing the denominator effect.

“What’s probably more relevant today is this home bias, where investors are just shifting to what they’re more familiar with, what they feel is safe, and where they’re reallocating away from stuff that’s very far away from them,” Wolff said, flagging deal drivers such as personnel changes, regulatory changes, timing constraints, asset fatigue, and a desire to shore up balance sheets.

“Pinpointing one or the other is challenging, but we have observed that there is an increasing volume of LP-leds since the second half of last year, and specifically into 2023.”