Private Equity Secondaries: A Rising Star in the PE Industry
According to a recent McKinsey study, the private equity (PE) industry, representing $11.7 trillion as of June 2022, has seen consistent growth, expanding at an annual rate of 20% since 2017. A burgeoning segment of this industry that’s catching investors’ attention is private equity secondaries (PE secondaries), a niche that’s becoming more popular due to various market factors, including the need for portfolio rebalancing by institutional investors.
Understanding Private Equity Secondaries
At its core, private equity secondaries refer to the buying and selling of existing PE stakes from one investor to another. The secondary market provides a vital liquidity option for PE investors, often known as ‘limited partners,’ who otherwise cannot redeem their stakes until the PE fund reaches maturity. Typically, institutional investors such as hospitals, foundations, or public pension plans populate the selling side of the secondary market.
Factors Driving the Growth of PE Secondaries
Several elements are fueling the growth of PE secondaries. First, recent public equity and bond price declines have resulted in many portfolios being overweight in private equity exposure. As a result, these investors need to rebalance their portfolios, driving them toward the secondary market. Second, the compression of the private equity fundraising cycle from roughly four years to only two means that limited partners are often overcommitted to newer private funds and require liquidity from existing investments, adding to the supply of secondary investment opportunities.
The Upsides of PE Secondaries
Several factors make PE secondaries an attractive investment prospect. For instance, these stakes often sell at a discount to the net asset value (NAV) due to the illiquid nature of the market and the seller’s liquidity needs. Furthermore, PE secondaries offer greater transparency compared to traditional PE investments, allowing buyers to conduct extensive due diligence on the underlying investments.
PE secondaries also provide broader diversification across industries, sectors, investment years (vintages), and risk factors than a single PE fund or deal. Lastly, multiple layers of due diligence are typically applied to the investments and their management teams when accessing secondaries via a dedicated fund.
Risks Associated with PE Secondaries
Despite their allure, PE secondaries do come with their unique set of risks. As with all private market investments, secondaries are illiquid compared to public equities and bonds, necessitating investors to commit their capital for extended periods. Moreover, the complexity of the PE secondary market demands extensive research and due diligence expertise.
Buyers must evaluate specific assets using their own resources and expertise, requiring them to analyze financial statements, assess management teams, and understand the underlying industries and markets for each opportunity. This is why many investors access secondaries through a dedicated secondary manager.
Are Private Equity Secondaries Right For You?
As the trend towards PE secondaries continues to gain momentum, potential investors must contemplate if this investment strategy aligns with their financial objectives and risk tolerance. The distinctive benefits of PE secondaries, such as the possibility of acquiring assets at a discount, increased transparency, and heightened diversification, may be compelling for seasoned investors.
However, it’s essential to acknowledge this asset class’s unique challenges, particularly regarding the need for extensive due diligence and longer capital commitment periods. It’s recommended that prospective investors consult with experienced advisors or dedicated secondary managers to determine if PE secondaries are a suitable addition to their investment portfolio.
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