The secondary market can often relieve liquidity issues for investors in private equity by offering the opportunity to sell existing investments to another buyer.
Many areas of the private market tend to be illiquid by design, which can allow long-term investments to realize their full economic potential, but can also create challenges for investors that require some degree of flexibility. The secondary market can often relieve liquidity issues for investors in private equity by offering the opportunity to sell existing investments to another buyer. There are several strategic reasons investors might consider this approach, particularly given recent macro dynamics:
- The “denominator effect” – Public market valuations fell sharply in 2022, while private markets, which tend to re-rate more slowly and may experience less volatility, were relatively resilient. This left some portfolios inadvertently overweight alternatives relative to their targets. Secondaries have allowed for rebalancing in a portfolio.
- Distributions – Toward the end of an investment period, investors may receive distributions from specific investments, which include return of principal plus gains. Recently, distributions have been challenged as the exit environment (e.g. M&A, IPOs) faces headwinds. Secondaries can offer liquidity faster than the distribution schedule may allow.
- Reallocation – Investors may want different exposures to sectors, geographies and vintage years in their portfolios, which secondaries can provide to both buyers and sellers.
- General liquidity – There are many reasons an investor may simply need access to their funds, so secondaries can be a general source of liquidity beyond portfolio construction reasons.
Benefits extend to the buyers of secondary investments as well. In addition to the ability to reallocate exposures, buyers can get access to attractive opportunities that would otherwise not be available to them and can often benefit from discounted pricing.
As highlighted in the chart below from our Guide to Alternatives, although volume has abated somewhat in 2023 relative to the last two years due to recovering public markets and an uptick in pricing, activity in the secondary market is structurally stronger than over the past decade. However, the pipeline for deals is likely to remain robust given USD 1.3 trillion in dry powder in private equity and a limited universe of new targets. Investors may find the best opportunities in less cyclical, higher quality assets in the small to middle-market space given elevated macro risks.