The illiquidity of private markets reflects the nature of the underlying assets. Investments in private equity, venture capital, real estate, and other alternative assets often involve long-term commitments. Limited partners (“LPs”) entrust general partners (“GPs”) with managing these assets and executing a value creation strategy—whether through revenue growth, market share expansion, or mergers and acquisitions (“M&A”). These investments, unlike public market assets such as stocks or bonds, often tie up capital for years, limiting the investor's ability to sell or rebalance when needed.
Direct investments in private markets represent the “primary markets,” where capital is allocated directly to companies or assets. By contrast, secondary markets allow investors to buy or sell existing private market investments, providing much-needed liquidity to private equity and alternative asset classes. GPs and LPs can both initiate secondary transactions to solve the illiquidity challenge.
GP-led transactions often involve fund sponsors selling assets from an existing fund to a new fund. These “continuation vehicles” allow GPs to continue managing the same assets while providing liquidity to investors.[1]These transactions may be driven by liquidity needs, portfolio restructuring, or fund optimization. Investors can exit their positions while new investors enter, ensuring the continuity of the investment strategy.
Despite macroeconomic challenges, the GP-led secondary market showed resilience in 2022, representing around 42% of total secondaries volume in the first half of the year, with a market size of approximately US$24 billion.
Unlike a sale to another private equity sponsor, GP-led secondaries allow the same sponsors to continue their investment strategy without having to renegotiate the existing leverage on investments or disrupt portfolio-company management teams. LPs have the option to either cash out or roll into the new continuation vehicle to maintain their exposure to the investments, often at more LP-favourable economics.
When IPOs are at relatively weaker levels and mergers and acquisition activity slows significantly, GP-led secondaries allow sponsors to provide proceeds to existing investors at favourable pricing.
LP-led transactions, by contrast, are typically one-off sales where LPs seek to sell their interests in private funds. Buyers in LP-led secondaries, which may include institutional investors or secondary funds, assume the LP's rights and obligations. LP-led transactions can involve single LP stakes or portfolios spread across multiple funds, allowing sellers to rebalance their exposure or meet immediate liquidity needs.
Investors weigh several factors when choosing between GP-led and LP-led secondaries, including diversification, potential returns, and their immediate liquidity requirements.
Figure 1: The growth of the secondaries market
Source: Pitchbook
The Benefits of Secondary Transactions
Both GP-led and LP-led secondary transactions offer essential liquidity to investors who wish to exit private market investments. These transactions provide investors with more flexibility by offering transparent pricing for private assets, making it easier to understand the true market value. Secondary transactions also allow investors to diversify their portfolios, mitigating risks and reallocating capital to more promising opportunities. Sellers can reduce their exposure to underperforming assets, while buyers gain access to private investments with shorter holding periods, which is reflected in the pricing.
The shorter the holding period, the higher the cost. However, this shorter duration also provides greater flexibility.
Secondaries also help mitigate “blind pool risk,” which is common in primary funds where LPs commit capital to an undeveloped portfolio. By investing in secondaries, investors can better assess the performance and risks of the fund, improving their ability to make informed investment decisions.
Additional Advantages for Buyers
Secondary investments offer several additional advantages to buyers.
Lower Fees. Secondary funds generally charge lower fees than primary funds, as GPs act more like portfolio managers overseeing existing assets, rather than actively managing and creating value within the individual companies.
Early Liquidity. Secondary funds often invest in multi-vintage portfolios, balancing commitments against distributions. This leads to early liquidity and a much shallower J-Curve compared to primary investments.
In conclusion, secondary markets within private equity and alternative asset classes usher in a new era of liquidity and flexibility. These markets allow investors to navigate traditionally illiquid investments with greater ease. As the secondary market continues to evolve, its ability to address the illiquidity challenge cements its place as a critical component of modern investment strategies.
Key Takeaways
The secondaries market has expanded rapidly since the global financial crisis, providing much-needed liquidity and flexibility to private markets.
Investors benefit from diversification, cost reduction, and risk mitigation when participating in secondaries.
These markets present investors with new opportunities to achieve their financial goals while transforming the landscape of private equity and alternative investments.
Did you find this article informative? Learn more about secondary markets’ advantages and benefits for investors and don’t miss this article about The Family Office’s secondaries marketplace.