Secondary Markets: Providing Liquidity in a World of Illiquid Alternatives

The secondary market refers to the buying and selling of pre-existing investments. In our first webinar of 2021, Excelsior Capital hosted secondary market industry experts Raphael Haas, Doug Reid, and Joe Dios of Melting Point Solutions to give a broad overview of the market as a whole and share what sets their firm apart in this space.

In this webinar, panelists discussed the following:

• An overview of the secondaries market
• How the market was born
• Characteristics of typical participants in this market
• What the selling process looks like
• Why investors should be aware of this market
• The biggest do’s and don’ts within the market
• The future of the secondary market

What are secondaries?

Haas opened the discussion by sharing a high level overview of the secondaries market as a whole: “It broadly refers to the market for liquidity for illiquid alternative assets.” When someone is invested in an illiquid asset, usually in the form of a fund, and when there aren’t redemption terms available, this is the best market to achieve liquidity. While it’s not a formal market with an exchange, it does offer buyers and sellers great opportunities.

Almost seven years ago, after realizing that most sub-institutional investors didn’t have access to the secondary markets, Haas launched Melting Point Solutions, a secondary market intermediary. The firm serves only as a facilitator of sales, not as a buyer or seller themselves. Their ultimate goal is to help investors achieve liquidity in their otherwise illiquid alternative assets. This is accomplished by taking a seller’s assets out to market then holding a competitive auction with their group of about 400 buyers (made up of family offices, wealth funds, and “everything in between”).

How was the secondaries market born?

Next, Adams questioned Haas on when secondaries became market-participant, asking why investors started to focus on them among other options. Haas responded that the market has actually existed for nearly 40 years now, however, there were only a handful of buyers and sellers up until the great recession. “The GFC brought about the first systematic reason or need for selling. Endowments, pensions, and investors found themselves in a severe financial imbalance with cash flow needs that couldn’t be met.”

This “bonanza” from the buy side sparked the formal growth of the secondary market as many large groups began launching their own dedicated secondary funds. While it used to be a cottage industry, it’s now dominated by the large buyers. The industry as a whole operates between $80-$100 billion per year and is growing steadily.

Who is a good fit for the secondary market?

“From a structural standpoint, are these only available to traditional GPs or LPs?” Adams sought to learn more about the criteria for a typical secondary market participant. Haas shared that they typically work with traditional limited partnership interest in funds. While their universe is quite diverse, they have two distinct requirements for all of their funds:

• Dilligencable
• Transferable

And with such simple criteria, “there’s usually a market for anything.”

What does the process typically look like?

Moving onto the next panelist, Reid shared more about what differentiates Melting Point Solutions from their competitors. “Unlike many of our peers, we have a singular focus, one thing that we do very well.” That one thing is running a competitive sales process in order to maximize price for their sellers within the secondary market. Here’s what the process typically looks like:

1. They are hired by a seller of an asset or portfolio of assets for an exclusive period of time. Seller anonymity is always maintained throughout the process.
2. They set up a data room with diligence on each position. (The more diligence that can be provided to buyers, the better the pricing and process will be.)
3. They run a formal auction process that is time-restricted, showing the assets only to their buyers that they know would be interested and pre-approved.
4. They solicit bids at a deadline, which could take anywhere from two weeks to two months.
5. They analyze each of the bids and solicit line-item pricing to present the seller with a range of options. The seller always has the right to refuse the sale, but they’ve had over a 90% conversion rate in their seven years of business.

What are the biggest do’s and don’ts in secondaries?

Reid provided some of his most prominent pieces of advice for anyone considering the secondary market.

Biggest Do: Hiring an intermediary who will work to find the highest price at any time

Biggest Don’t: Doing it by yourself in hopes of stumbling upon a high price

He commented that “it may sound self-serving, but, even net of our fee, because of the average spread of our bids, it always pays off to hire an intermediary.”

What should we expect for the secondary market over the next year?

“With the high rise in popularity of alternatives and a new administration coming this year, can we expect any regulations or barriers to entry to change?” The response by Haas was not as hopeful as Adams may have expected when he answered with various tax impediments, hidden incentives, and regulations that have kept the secondary market from leaping forward. According to his predictions, an exchange is not likely to happen anytime soon.

However, Haas has seen a larger trend of general acceptance of the secondary market as a whole, which gives him hope for the future a few years down the road. Ultimately, all parties involved in the market will benefit from a wider awareness of and participation in the market. There is certainly optimism moving forward!