Private market secondaries go ‘mainstream’ as exits slow down - but investors must act carefully – LCP

Private market secondaries are becoming a core allocation for institutional investors as private market exits have slowed and fund lives have stretched, according to investment experts at LCP.

A decade ago, secondary transactions were relatively niche, mainly involving specialist buyers purchasing fund interests from motivated sellers. Today, the market has grown to over $230bn p.a., supported by the rise in transactions linked to the underlying companies in funds, rather than  just the sale of fund interests.

LCP attributes this shift to higher interest rates and slower M&A activity, which have made it harder for funds to sell their investments, leading to longer holding periods and distributions to investors being delayed.

For many institutional investors, this has meant capital calls outpacing distributions, putting pressure on liquidity and portfolio allocations, and increasing the need to realise proceeds from existing fund holdings by selling them on the secondary market (LP secondaries). At the same time, managers have come under growing pressure to return capital to investors and have increasingly used asset-led secondary transactions (GP secondaries). This is often through continuation vehicles, to release liquidity from underlying portfolio companies and offer some investors an exit route.

LCP is seeing secondaries become more widely adopted, with a growing number of investment managers launching funds to purchase holdings through the secondary market.

This is unsurprising due to the potential benefits available, including:

• Tighter return profile: While secondary funds are less likely to deliver the outsized gains of top-quartile private equity funds, they significantly reduce downside risk.
• Increased diversification: For investors with smaller budgets, a single secondary fund can provide diversified exposure across managers, vintages and underlying companies, without the governance burden of building a multi-manager vintage programme.
• Better visibility: Secondaries can offer improved visibility over the underlying companies, sectors and performance. As these companies are typically more mature, future outcomes may be less uncertain than for earlier-stage investments, although some blind pool risk can remain.
• Earlier returns: Secondary funds are typically able to put capital to work faster compared to their primary counterparts, and have exposure to more mature companies with established revenues.

While the growth in the market is attractive, LCP cautions that institutional investors must take a considered approach.

Key considerations include:

• Assessing how secondaries fit within the overall portfolio strategy
• Monitoring market conditions closely
• Determining the most appropriate access route