What’s up in secondaries?
Liquidity has been difficult for LPs to come by and yet the secondary market wasn’t quite as active in 2023 as many had predicted. Why is this? And what comes next?
Liquidity has been difficult for LPs to come by over the past 12 to 18 months and yet the secondary market wasn’t quite as active in 2023 as many had predicted at the start of the year. Why is this? And what comes next?
In early 2023, many secondary market observers were anticipating an exceptionally busy year for deals as LPs found themselves over-allocated to private markets and as GPs sought to provide their investors with returns in a constrained M&A environment. Jefferies, for example, had predicted volume in excess of $120bn. Yet it looks as though the year will close out at around $100bn. That’s still the third most active year on record, but it’s a little short of predictions. So what’s going on? Secondaries investors and LPs offer their perspectives and look ahead to what might be coming down the line.
Private markets fund investors have seen crises before and, unlike in previous periods of liquidity crunch, they are not forced sellers. “One key reason the LP-led secondaries market is slower than anticipated is because investors are now smarter than ever,” says Paul Sanabria, Global Co-Head of Private Equity Secondaries at Manulife. “They are not capitulating, even as the bid-ask spread comes closer. Not as much capital has been deployed here as we’d have thought.”
Investors are now smarter than ever
Some of this has to do with the way investors approach private markets today, including using allocation ranges as opposed to absolute targets. “There is increasing sophistication and better information in the secondary market than the last two times we saw material liquidity issues,” says Sanabria. “That means conversations don’t just focus on price; it’s much more about outcomes. The kind of flexibility that public pension plans, for example, have today is leap years ahead of what we saw during the late 1990s tech crisis or the GFC. That means you have willing buyers and sellers but sellers have more short-term solutions so the market is meaningfully down from what was anticipated.”
The rise of GP-led deals has led to an almost doubling of the amount of capital needed to meet demand. And while there have been some significant fundraisings by secondary funds over recent times (even as fundraising more generally has become an uphill struggle for GPs in other strategies), assets under management in this segment of private markets still lag the opportunity, say many in the market.
“There is a buyer-seller imbalance,” says Lisa Sun, Managing Director at BlackRock. “Secondary players are trying to catch up in capital-raising, but the market is not there yet so it's currently a buyer's market.” PJT Partners recently estimated that there is around $170bn of dry powder available in the secondary market, equating to about one and a half years of investment – that’s down from the two or more years seen historically. “There are not enough people or capital in the market,” says Cari Lodge, Head of Secondaries, CF Private Equity. “Secondary volume is therefore slightly lower for 2023 than we thought it would be, and it meant that only the highest quality deals got done.”
There are many reasons for this, but one of the most common was pricing. “A lot of GPs wanted to get deals done through the CV route, but they wanted par or premium pricing,” says Sun. “That was what they were getting in 2021 and 2022, but the market has changed. We saw a lot of GPs pull back if they couldn’t reach their target pricing. It’s also an issue of quality – GPs have been encouraged to bring out their strongest performers, but if they are now on their third or fourth single asset GP-led deal, that story may get a bit diluted. There are only so many trophy assets out there and their LPs may want to see other realization paths.” With a dearth of capital in the secondary market, buyers can afford to be choosy.
There is a buyer-seller imbalance
With the IPO window remaining largely shut and M&A activity down sharply from recent years, GPs increasingly need to offer LPs some form of liquidity – and one route for the right companies is via GP-led deals. And there is continued demand for these among some LPs. “If I had my last $50m to invest, I would rather do a GP-led deal over a co-investment,” says Mina Pacheco Nazemi, Managing Director and Head of Diversified Alternative Equity at Barings. “That’s because the business has been battle-tested through Covid, labor shortages and inflation. We’ve seen it grow through the value creation strategies of the GP and see a path to continued growth. In a co-investment, you’re looking at a business for the first time.”
And it’s a view that – perhaps predictably – many secondaries players share. “GP-led deals are an attractive alternative to buyouts or co-investments,” says Amyn Hassanally, Global Head of Private Equity Secondaries at Pantheon. “If you create a portfolio of single-asset deals, you have the opportunity to achieve buyout returns, but with lower risk, shorter duration and greater alignment.”
Added to investor appetite is the fact that a whole ecosystem is building around these deals and the stage looks set for further expansion. “We’ve seen the investment banks build up teams and capability in GP-led deals as the M&A market is materially down,” says Sanabria. “An infrastructure around this liquidity solution is building as advisors smell fees and they are rapidly educating sponsors on the opportunity – this market is not going away.”
“The secondary market is a derivative of the primary market,” says Lodge. “So much primary capital has been raised recently, that between both LP-led and GP-led deals, we’ll see a big jump in secondary volume over the coming period. It may be choppy, but the overall direction is up and to the right.”
“The secondary market has proved highly adept at finding solutions to a whole host of private equity’s quirks and unusual features,” says Dorothy Kelso, Global Head at SuperReturn. “That’s from succession in firms and tail-end assets left in a fund that has reached the end of its life, and now to providing GPs with an alternative to selling and providing liquidity during a dearth of M&A opportunities.”
And there will no doubt be new problems to solve, including one that may well emerge over the coming period. “The secondary market will need to innovate and evolve again,” says Gerald Cooper, Partner at Campbell Lutyens. “There will be a lot of NAV sitting on the sidelines in the lower part of the market – this is where even good managers will struggle to raise capital. The secondary market could well provide a solution and liquidity for LPs here.”
