Secondary markets offer a liquidity solution to investors. They involve players who see value in buying or selling private market investments, often led by limited partners (LPs) and/ or general partners (GPs).
Liquidity, made accessible through secondary markets, allows investors to realize an earlier return on their investment. It may also allow employees to cash their equity compensation before an exit event, such as an initial public offering (IPO) or an acquisition.
Private equity (PE) investors, for example, rarely have a ready redemption option before the life of the fund ends. The secondary market is often the only option for LPs to exit earlier by selling their shares of non-public companies .
Institutional investors may wish to sell their PE holdings for many reasons. They may have become overweight in PE following declines in public equity and bond markets. The dramatic outperformance of PE in 2022, for example, made asset owners overweight in PE as public equity markets declined significantly. Other reasons for selling may include:
an investment that exceeded its original time horizon,
limited upside in holding an investment for a prolonged harvesting period, or
a changing investment mandate.
Pricing Secondaries
The pricing of secondaries is based on the valuations published by PE funds publish, typically quarterly, as a percentage of the reported net asset value (NAV). Typically, the buyer and seller agree a NAV valuation date (reference date) to determine the settlement of capital calls and distributions before the closing date. Post-valuation cash flows help to determine the final purchase price.
One advantage for buyers is that secondaries are often bought at a discount to NAV due to the illiquid nature of private markets. Pricing varies widely depending on the quality and type of companies in the portfolio and the maturity of the funds.
According to Private Equity Wire, PE secondaries are usually priced between 90% and 105% of NAV. Given that NAVs are typically updated quarterly, this method of pricing may lag public market movements by several months. Private Equity Wire added that, as of March 2023, discounts in the PE secondary market had grown to their highest in a decade.[1]
Types of Secondary Transactions
Secondary transactions may be led by either GPs (fund sponsors who sell one or more assets from a fund they already manage to a new fund) or LPs seeking to sell their interests in private funds to a buyer who assumes their rights and obligations therein (see Solving the Illiquidity Challenge: The Role of Secondary Markets).
To achieve the best price, LPs typically bring their best assets to the secondary market, according to Private Equity Wire. LP-led transactions represented over half of the secondary market in 2022.[2] LP- and GP-led transactions transaction volumes reached a record in 2022 according to PJT Park Hill, a secondaries advisory firm.[3]
GP-led transactions, once representing a small proportion of the secondaries market, have grown significantly. They offer sponsors liquidity events that provide proceeds to existing investors at favorable pricing.
The Rapid Growth of Secondaries in Private Markets
The private-credit secondaries market has also grown rapidly, with a record US$17 billion in transaction volume in 2022—30 times the levels recorded a decade earlier. LP-led represent most credit secondaries transactions, with deal flow driven by investor liquidity issues. However, momentum may also be building behind GP-led credit secondaries transactions according to the US law firm Cleary Gottlieb.[4]
Global sales of real-estate secondary transactions also reached a record US$12.4 billion in 2022, according to the alternative investment manager Ares Management, driven by investors’ need for liquidity. Activity is expected to remain high amid the uncertain outlook for commercial real estate. GP-led transactions involving the recapitalization of funds and property portfolios accounted for 77% of total secondaries sales volume according to Ares.[5]
Preqin reports that the real-estate secondaries market allows several approaches across a fragmented marketplace dominated by a few players, each with a differentiated angle on the market.[6]
In conclusion, the secondaries market continues to grow strongly, providing much needed liquidity to investors. It offers sellers an exit option, while buyers can often acquire secondaries at attractive discounts.
Key Takeaways
Secondary markets offer a liquidity solution to investors.
The secondaries market reached record volumes in 2022, and the momentum is continuing into 2023.
Sellers’ need for liquidity allows investors to acquire secondaries at a discount.