Rising participation in the secondary market
Vividly demonstrating how the cloistered world of private markets is opening up, half of all managers and investors surveyed indicate they will participate in the secondary market in 2021. This is dramatically higher than our survey six years ago, when only 28% of managers and 38% of investors planned to buy or sell in the secondary market. This finding is corroborated by a Coller Capital survey from mid-2020, which revealed that more than 50% of LPs planned to buy or sell secondaries.6 Purchases are more common than divestments, with more than 40% of all survey participants planning to buy secondaries in 2021, and only 24% planning to sell.
Change is visible across the industry but it is most evident among managers, where there was an eight-point rise in the number planning to buy secondaries and a five-point rise among the number of those selling (Figure 4). This uptick in sellers reflects growing interest in continuation funds, which are seen as a win-win for investors and managers.
Brian Mooney, managing director and co-head of GP-led secondaries at Portfolio Advisors explains: “From an existing limited partner’s perspective, a successful outcome typically achieves a fair, market-driven price for those investors that wish to sell and an attractive option to ‘roll’ should they prefer to retain their exposure to the asset and sponsor… For general partners, there are myriad goals that continuation transactions can achieve. Most importantly, these transactions provide GPs with additional time and often additional capital to maximize value of the subject asset(s) while delivering optionality to existing LPs.”
Aided by a growing number of transaction venues, investors welcome the opportunity to access liquidity more conveniently and manage their portfolios more actively. This is especially true in the emerging post-COVID world, where assets in so-called tail-end funds have ballooned.7 According to David Lowery, head of Research Insights at Preqin, “LPs are increasingly active in the secondary market, primarily for portfolio management reasons such as active management and portfolio rebalancing.”
More confident about navigating the less familiar world of secondaries, managers are far more likely than investors to buy or sell directly (Figure 5). Investors are distinctly more interested in buying secondaries than selling them, and they prefer to do so via intermediaries or funds of funds. Overall, the secondaries market is becoming much more intermediated compared with six years ago, when direct purchases and sales easily outpaced other methods.
Only a third of all participants say they plan to avoid the secondary market indefinitely. One in five does not plan to participate in 2021, but suggest they are open to buying or selling secondaries further down the road. Portfolio Advisors’ Mooney says, “We expect the LP secondary market to continue to grow as more institutional investors adopt these transactions as a portfolio management tool. However, we also believe that GP-led transaction volume will outpace LP secondaries.” He goes on to note that “while the GP-led secondary market was originally defined by older assets and ‘zombie’ funds, volume and usage of continuation transactions is now dominated by brand-name sponsors, which gives the market true institutional credibility and staying power.”
Current valuations for secondaries
COVID temporarily deflated private market activity, and the secondary market is not exempt. If nothing else, it was an opportunity for the market to cool down and reset. By the end of 2020, few investors or managers think valuations are extremely out of line (Figure 6). Although many think the market is fairly valued, the rest are skewed toward those who consider the market for secondaries to be somewhat overvalued. It is worth noting that, both managers and investors are more likely than they were six years ago to say that secondaries are undervalued (Figure 7). Even more striking is how much more aligned GPs and LPs are in 2020. Thanks to the transparency ushered in by deal volume and data access, perceptions that were vastly different in 2015 are virtually indistinguishable today.
Role of third parties in the secondaries market
As the appeal of secondaries continues to spread, deal making continues to evolve. Alternatives platforms from entities such as Nasdaq and iCapital are vying for mind- and market share with traditional go-betweens such as Cogent Partners and Campbell Lutyens. With the number and variety of intermediaries mounting, their roles are evolving beyond the identification of buyers and sellers to include transaction structuring, data room management, and negotiations.
Investors are more inclined to value the participation of third parties in the secondaries process, saying they are particularly valuable when it comes to matchmaking and pricing (Figure 8). Managers are more sanguine, especially in negotiating or pricing deals, with one out of three saying third parties are simply unimportant.
A reputation relegated to history
It was not long ago that many looked askance at secondaries, viewing them as a somehow less reputable version of the primary market for private securities. Some of this was rooted in the idea that a sale on the secondary market indicated a seller in distress. Nowadays, secondary transactions are more likely to reflect investors taking a more active approach to managing their portfolios.8
Attitudes have shifted over time, and the recent introduction of dedicated secondaries funds by industry titans has highlighted the mainstreaming of this once decidedly ancillary market. BlackRock raised $3 billion to invest in private equity secondaries in early 2021, noting at the announcement that “We believe that the secondary market is poised for strong future growth as limited partners and general partners alike seek more creative ways to access liquidity and realize value.”9 Other notable firms like TPG and Ares established footholds with acquisitions, and Apollo Global Management is rumored to be planning its own entry into the secondaries market.10
More than half of all survey respondents say there are no longer any taboos associated with selling secondaries (Figure 9); this figure is up five percentage points from our 2014 survey. There are holdouts: One manager in the survey characterized the secondary market as consisting of “unsuccessful funds or unhappy investors,” and a few investors worried that a secondary sale could hint at underlying problems. Most survey participants, however, are likely to find little or no stigma remaining. One noted that the motivation for a deal might need to be explained, but others insisted that the market had moved on and secondaries are widely seen as a standard portfolio management tool.
The net result of this swing in perspective is more liquidity for industry veterans as well as for those adding private market assets to their portfolios for the first time. Liquidity may not be the ultimate objective; instead, it can be a means to an end. According to iCapital, “Secondary transactions can help investors reduce their number of general partner relationships, meet regulatory changes that require a reduction in private market exposure, and address asset allocation shifts at the direction of their investment teams.”11
Transparency in the secondaries market
A key hurdle in the way of an even wider embrace of secondaries is the paucity of transparency. There is widespread agreement that more clarity would benefit the secondaries market. Investors in particularly are eager for more transparency, with fewer than 1 in 10 saying they didn’t think it was necessary (Figure 10). Recognizing its pivotal role, many are rushing in to address this pent-up demand. Infomediaries and industry media promote the flow of information. Markets and exchanges create feedback loops that amplify transparency. Data and service platforms are making it progressively easier for managers to provide greater access and insights to investors.
In an interview with Private Equity Wire, Julien Gervaz, CEO of secondaries platform Palico, points out that private markets have a lot of ground to make up: “If you look at what has been done on the public side in the ’80s, standardize(d) trading information and the logistics associated to it made everything easier. PE is usually 10 to 15 years behind the public markets in the way information is handled.”12continue reading
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