Background

Economic events, such as the 2022 Gilt Crisis, have had a positive impact on the funding positions of UK defined benefit (DB) pension schemes to the point that £500bn of assets are expected to be transferred to bulk annuity insurers over the next decade. Recent volatility in markets isn’t expected to have a significant impact on this direction of travel.

Illiquid fund interests present a potential barrier to many schemes looking to transfer to an insurer, meaning they need to explore secondary market sales. Often this is the first time a scheme has needed to utilise the secondary market, which can be complex and challenging.

This paper explores:

• The challenges for sellers looking for liquidity via the secondary market

• The opportunities for buyers to access these fund interests

• How online platforms such as MeltX can help simplify secondaries for both sellers and buyers  

The challenges for sellers

First time sellers on the secondary market are presented with some challenges. In particular:

• A disaggregated market. Unlike traditional assets, there is no centralised platform for the trading of LP-led secondary interests. Sellers need to know who the potential buyers are, understand their processes and run a competitive bidding process. Sellers also need to consider best execution in terms of pricing and the credibility of those potential buyers

• Lack of price transparency. The lack of a centralised platform also means there is minimal transparency in terms of pricing. Advisers can provide guidance based on similar transactions, but ultimately the pricing will depend on market conditions and the specifics of the fund interests. Sellers need to be sure that the pricing they accept is generating the best value for their stakeholders/members

• Complexity. In addition, sellers need to understand the different bid structures utilised by buyers (including  deferrals and contingent payments), how to structure the sale process to maximise interest from buyers and how to ensure the underlying fund manager consents to the sale. In addition, the legal aspects of a secondary transaction can be time consuming, costly and risk the transaction falling over

These challenges mean many UK pension schemes decide to take specialist advice to help navigate secondary transactions. This includes  relying on their investment consultants, engaging specialist brokers, using dedicated secondary platforms such as MeltX, or any combination of these. 

The opportunities for buyers

Fund interests being sold by UK pension schemes present a compelling opportunity for secondary buyers. The key benefits include:

• Visibility of assets and cashflows. Unlike a primary allocation, with secondaries you usually know exactly what assets are in the underlying portfolio (a.k.a. avoiding blind pool risk). These assets are also often a few years into their lifecycle, meaning they are usually generating cashflows straight away (a.k.a. J-curve mitigation). 

• Discounted pricing. Due to their strong funding positions and need for liquidity, many UK pension schemes are willing to accept a discount to the value of their secondary holdings (a.k.a. a discount to NAV). For buyers this enhances the long-term expected return of their investment, without increasing the risk profile of the portfolio

• Scale. Many secondary buyers are focused on large fund positions and portfolios. A booming primary market for private markets in the UK over the last decade means there is plenty of stock for potential secondary sales. This trend should continue, with the UK Government continuing to encourage significant institutional investment into private markets

Who are the potential buyers?

Specialist fund of funds continue to be the main buyers of secondary fund opportunities. However, the evolution of the UK institutional market means other types of investor are well positioned to capture more secondary fund opportunities in the future. In particular:

• Run-on/open DB pension schemes. More DB pension schemes are looking to run-on to capture surpluses for their sponsors/members. There is an opportunity for these schemes to enhance their surpluses through buying secondary fund opportunities from the schemes that are looking to buy-out. Similar dynamics also apply for open pension schemes and specialist consolidators

• LGPS Pools. All Local Government Pension Scheme (LGPS) funds in England and Wales are expected to have pooled their assets within the next year or so. The six remaining LGPS pools are continuing to grow their private markets teams, potentially allowing them to transact faster on secondary fund opportunities

• DC Master Trusts. Many DC Master Trusts are looking to enter private markets for the first time and build-up multi-billion pound portfolios over a relatively short period of time. With the DC market starting to focus more on value over costs, there is an opportunity for Master Trusts to acquire attractive secondary fund opportunities. This will help them get instant exposure while diversifying the vintages of their private markets allocations

With many of the above investors looking to grow to £20bn+ in assets and expanding their in-house teams, they are acquiring the necessary expertise and governance to transact on more secondary fund opportunities. A key challenge will be accessing high-quality opportunities.

How MeltX simplifies secondaries for sellers and buyers

With sellers continuing to look for liquidity and new buyers entering the secondary market, there is a need for a more efficient and simple way of connecting these parties and facilitating the transactions. 

This is where MeltX plays a crucial role by providing a transparent, efficient and secure online platform for transacting LP-led secondaries. This leads to:

• Extended reach. By aggregating a wide range of secondary opportunities, MeltX maximises deal exposure by connecting more sellers with more buyers

• Efficient processes. MeltX's technology streamlines the due diligence, bidding and transaction processes, reducing time, costs and complexity for both sellers and buyers

• Enhanced transparency. By providing a centralised platform for secondary transactions, MeltX contributes to greater market transparency and price discovery