Just 20 years ago, secondary funds were virtually unknown outside specialised circles. Fast-forward to 2023, and four of the 10 largest funds raised were secondary funds. Over the past two decades, secondaries have transformed from a niche market segment to a pivotal component of the broader financial landscape, delivering much-needed liquidity during a challenging fundraising period.
Initially driven by the need for short-term liquidity and portfolio rebalancing, the secondaries market has since expanded and evolved. Secondary funds raised 92% more capital in 2023 than they did in 2022, contributing to the second-highest year of closed transaction volume on record, and 2024 is expected to be another record year.
But are secondaries a long-term solution to help relieve market pressures, or are they a flash in the pan? In this article, we’ll explore the types of secondary transactions, examine recent trends, and share our predictions for the future.
What are secondary funds?
In the context of private equity, ‘secondaries’ refers to the buying and selling of pre-existing investor commitments to PE funds and other alternative investment funds. These transactions offer liquidity to investors and present opportunities for new investors to acquire stakes in funds that are already partway through their investment cycles.
With exit markets sluggish across the alternatives industry, funds have struggled to find ways to get cash into the hands of investors and meet GP demand. Enter secondaries, a small but rapidly growing asset class.
Secondary funds have grown explosively over the past decade, particularly in the wake of the COVID-19 pandemic. At least in part, this growth is attributable to the $3.2 trillion unrealised value of 28,000 unsold companies weighing down buyout portfolios globally—a backlog four times larger than it was during the global financial crisis (by value).
As markets recover and the liquidity crunch subsides, there are still plenty of reasons to expect demand for secondaries to continue. LPs cite secondaries at the top of their list of the most attractive PE strategies over the next year. According to Preqin’s Investor Outlook: H1 2024, LPs see secondaries as the best opportunity in private equity. Investment volume is estimated to exceed $130bn in 2024, a significant increase over 2023’s record numbers.
GP-led vs. LP-led secondaries
Secondaries are especially useful when asset valuations are low, buyers are scarce, and exits are less attractive. They enable GPs to return capital to investors through sales to continuation vehicles or to facilitate liquidity via tender offers. This approach also allows investors to pledge cash for new fundraises.
GP-led transactions
General Partners (GPs) initiate GP-led transactions, setting up continuation funds to retain valuable assets that promise more future upside. GP-led deals account for roughly 40% of the secondary fund market and have risen in popularity thanks to limited exit options and a desire for value retention.
As traditional exit routes become less viable, GPs prefer to retain ownership of valuable assets, anticipating higher future returns. This trend has established GP-led secondaries as a new normal for PE exits. Pricing for GP-led transactions has remained fairly consistent, with most single-asset deals pricing between 91% and par.
LP-led transactions
In LP-led transactions, Limited Partners (LPs) sell their investment positions in funds to other investors. When macroeconomic conditions are volatile, LP-led transactions tend to dominate secondary market volume.
This type of transaction has seen considerable growth recently, driven by several factors including demand for liquidity, regulatory constraints that necessitate portfolio rebalancing, and the ‘denominator effect’. The denominator effect occurs when prices of public equities and bonds decrease and investor portfolios become over-allocated to private markets.
According to a 2024 report from Moonfare, most secondary deals are completed at a discount to net asset value (NAV). Most LP-led portfolio pricing sits at around 80-95% of NAV, with the strongest pricing across buyout, credit, and infrastructure strategies in developed markets.
The benefits of secondaries during volatile times
For limited partners (LPs), secondaries serve as a tool to rebalance portfolio exposure across strategies, geographies, and funds. They can also prematurely lock in investment gains, allowing LPs to sell stakes before the end of the fund’s lifecycle and increasing their ability to maintain liquidity.
GPs use secondaries to generate liquidity when exit markets are dormant (as they are today). Fundraising challenges have also intensified; a recent report from Bain & Company shows only $1 of LP capital available for every $3 of GP demand. Managers are actively seeking alternative ways to generate capital flow to investors, and secondaries offer a mutually beneficial strategy.
But secondaries aren’t merely useful; they also deliver consistent returns for investors with less volatility than most alternatives. In fact, secondaries are the only alternative asset class where even the bottom quartile of funds delivers a positive return.
Recent trends in the secondaries market
Increased activity
Despite broader market challenges, the secondaries market has seen record-breaking fundraising in recent years. As Moonfare recently reported, secondaries are the only group defying the overall decline in private markets fundraising.
Expansion into new asset classes
The secondaries market is no longer confined to traditional private equity, but is expanding into additional asset classes including real estate, venture capital, infrastructure, and debt. This diversification highlights the market’s adaptability and growing appeal across different investment sectors.
LP-led trends
William Blair notes a fourfold increase in LP-led secondary transitions to generate liquidity relative to 2022, and the latest Lazard Report also highlights a current preference for diversified LP-led portfolios.
Multi-asset continuation funds
Rising volumes of multi-asset continuation funds are fuelling continued growth in GP-led secondaries. There has been a recent surge in multi-asset continuation funds, allowing managers to realise liquidity from multiple assets within a single transaction.
Secondary success stories
Recent headlines abound with examples of secondary fundraising, including:
- Moonfare recently launched a secondaries evergreen fund targeting a balance of GP-led continuation vehicles and LP-led secondaries.
- Blackstone held their final close of secondaries strategy Strategic Partners IX in H1 2023 at $22.2bn, with approximately $5bn deployed as of December 2023.
- Ardian Secondary Fund IX is reported to have raised $20bn of its $25bn target as of December 2023.
NAV financing vs. secondary sales
Net Asset Value (NAV) financing also has a crucial role to play, offering an alternative to secondary sales. NAV financing provides liquidity without requiring the sale of assets, allowing investors to stay invested while accessing needed funds. NAV financing also enhances investment capacity, enabling investors to capitalise on new opportunities within their portfolios.
NAV solutions are quicker to execute than secondaries; however, NAV financing is more likely to be cyclical, rising and falling with the market. Despite the challenges, NAV provides a competitive cost of capital and helps preserve potential future gains, making it an appealing option for LPs during liquidity crunches.
The future of secondaries is bright
Based on trends and activity over the past several years, we expect to see continued growth in the secondaries market, driven by its expansion into additional asset classes and innovative strategies. Thanks to their unique ability to provide liquidity and flexibility, secondaries have become a vital component of modern investment portfolios.
As the secondary fund market grows, it offers valuable opportunities for both institutional and retail investors, making strategic portfolio management and liquidity solutions more powerful than ever.
At IQ-EQ, our expert team is perfectly positioned to support your secondary investments. From advanced reporting capabilities to fund administration and corporate services, we serve as an extension of your team.
Get in touch today to learn more.
About the author
Emmanuelle Dotezac is Funds Director at IQ-EQ in London. With a focus on business development, she works closely with private equity fund managers and private asset owners across the globe to meet their administration needs. Before joining IQ-EQ, Emmanuelle has built up almost 20 years’ experience in private and investment banking, advising private equity senior partners and entrepreneurs.
