The Role of Secondaries Markets
The secondaries market has seen tremendous growth in recent years, assisting the expansion of private markets into a more diverse and liquid asset class. Transaction volumes by secondaries funds increased to $108 billion in 2022 from $37 billion in 2016, with roughly half of these investments now coming from general partners (GPs) seeking more flexibility in their holding periods by launching continuation funds, according to Jefferies’ “Global Secondary Market Review.”
The selling of limited partner (LP) portfolios, the other side of secondaries investing, is also gaining traction, with about half of 2022 sellers adopting this liquidity instrument for the first time.
Secondaries, like index, or exchange-traded, funds helped popularize public markets in the 1970s, will be a significant driver for private markets to penetrate the large opportunity set in the private wealth segment, according to Andres Small, managing director at Partners Group.
With rising demand for historically high returns for private equity investments, there is a rethinking of the asset class’s appropriate duration as an investment. Investors in private markets want to move beyond the 10-year period arbitrarily chosen decades ago, while limited partners (LPs) want to see their capital returned sooner than the 10-year period or more that it can take to fully liquidate a private equity fund, partly because they’re now managing portfolios more proactively, added Small.
Secondaries are critical in offering this flexibility. For example, LPs can generate liquidity by selling their current investment in private equity funds or rebalancing existing portfolios to obtain the necessary asset class exposure.
Simultaneously, private equity managers have recognized that the secondaries market can provide a means to extend their hold on valuable assets with a lengthy avenue of value and growth potential. Transferring high-quality portfolio firms to continuation vehicles has become an alternate exit strategy to a sale or an initial public offering.
These extended secondaries let managers continue compounding profits on prized assets while also providing potential liquidity to LPs who desire it.
What makes this setting particularly intriguing is that there was only about a year’s worth of dry powder in the secondaries market at the end of 2022, compared with nearly 20 months of capital overhang excluding leverage for global buyouts, according to Bain & Company’s “Global Private Equity Report 2023.”
It provides interesting possibilities in infrastructure secondaries investments, according to Blackrock. Secondaries infrastructure is the fastest growing sub-segment, with a 54% average annual growth rate over the last five years, citing Preqin data.
Today’s secondary funds are being expedited by “yesterday’s primary funds”, which have raised more than $800 billion in total over the last decade, according to Blackrock.
As these funds mature and the number of infrastructure GPs and LPs increases, a varied base for secondary transaction activity emerges. In short, secondary growth is driven by the market, the GP, and the LP.
Secondaries transactions provide more rapid and visible investment into normally mature operating portfolios, which provide higher initial yields and shorter duration exposure, often with an early return of money.
Today, the convergence of these factors has created an appealing moment for infrastructure secondaries, a sophisticated, multi-faceted opportunity set with execution complexity spanning traditional LP-led and non-traditional GP-led transactions. Investors who have the origination and underwriting engine to deal with it have the ability to create significant risk-adjusted returns, explained Blackrock.
Secondaries investments made in the aftermath of an upheaval in the markets have historically produced some of the strongest vintages, thus 2023 and 2024 are anticipated to generate significant returns. In retrospect, the current secondary market may resemble the buying opportunities that became available in 2009 and 2010, according to Small.
