In the secondary investment market, existing positions in investment funds or companies are sold. The investors in this market are often large institutional investors such as pension funds, family offices, or insurers—so-called limited partners. They can sell their fund participation to other limited partners or specialized funds that exclusively invest in secondary positions, like ICG.
There are two types of secondaries: LP-led secondaries and GP-led secondaries. LP-led secondaries are driven by the liquidity needs of investors in PE funds. This involves large institutional investors such as pension funds, family offices, or insurers, a group we refer to as Limited Partners (LPs). This group periodically needs liquidity for various reasons. This can be due to changes in the investor's strategic investment policy or because the investor's investment portfolio becomes unbalanced. The GP-led secondaries category mainly consists of positions in 'continuation vehicles,' structures where investments in companies from expiring funds are placed so that PE funds can hold these investments longer, for example, to add more value or to complete an integration after an acquisition. In these transactions, the General Partners—the GPs—of the PE funds take the lead.
What are the main differences between investing in a secondaries fund and a typical PE fund?
A clear difference from a typical PE fund is the duration. Secondaries investments generally have a shorter remaining duration and are more liquid because the funds have been active for years before you step in. This helps mitigate the 'J-curve' effect, where the investment and 'harvesting' periods are shortened. Additionally, in some cases, there can be early unrealized returns because transactions can be closed at a discount compared to the intrinsic value (NAV). The average discount in PE secondaries transactions in 2023 was about 9%.
Average discounts on LP portfolios (% below NAV).
Source: Jefferies (2024). 2023 Global Secondary Market Review.
"Both GP-led and LP-led secondaries generally offer diversification advantages compared to typical PE funds. In LP secondaries, this advantage is greater than in GP-led secondaries, simply because more portfolio companies are usually part of a transaction, encompassing more diverse sectors, vintages, and regions.
Finally, there is more transparency in secondaries, meaning better insight into what is in a portfolio before you invest. In LP secondaries, you have a clear view of the companies in the portfolio you are purchasing, while the underperforming companies are usually already (partially) written off. In the case of GP-led secondaries, the fund manager tries to "cherry-pick" the best companies from portfolios and acquire them at an attractive valuation. All of this makes investing in secondaries funds highly complementary to investing in traditional PE funds."
Indicative cash flow profile for an investment in a secondaries fund compared to a primary fund.
Source: Marktlink Capital (2023).
What risks and considerations should investors in secondaries funds take into account?
In addition to general macroeconomic factors such as economic growth and interest rate developments, it is important to avoid pitfalls in secondaries. The discipline of the fund manager and the concept of "stick to your knitting" are important here. LP-led secondaries and GP-led secondaries are fundamentally different strategies, and we believe that specialized knowledge and skills are needed for both. In LP-led secondaries, the results are generally more stable because diversification on multiple levels is inherent to the strategy. In GP-led secondaries, you can aim for higher returns due to higher concentration, but the return will be more dependent on the performance of a few companies and possibly somewhat more volatile. If you analyze specific companies for a GP-led deal, you must be able to put yourself in the role of a buyout investor. While if you have to analyze a portfolio of dozens of funds and hundreds of companies under time pressure, as in an LP-led secondaries deal, you need different qualities, network, and data and technology.
Distribution of net Internal Rate of Return ('IRR') per investment category.
Bron: Brain Global Private Equity Report 2024. Grafiek heeft betrekking op vintage jaren 2000-19, actueel per Q2 2023.
What is the current market dynamic and what are the driving forces behind the strong growth of the secondaries market at the moment?
The secondaries market has grown significantly in percentage terms over the past decade, albeit from a small base. While in 2023 there were approximately $3.2 trillion in portfolio companies in PE funds (28,000 companies), the secondaries transaction volume was relatively modest at over $110 billion (see figure next to it). For comparison: in the market for publicly traded stocks, $200 billion is traded daily in the US alone. The light gray line on the graph to the right indicates what portion of the entire PE market consists of secondaries. This was about 8% in 2023, indicating significant growth potential for the future.
When we look at the supply side of the secondaries market, or the investors who want to sell their participations, we see that the liquidity needs of fund investors and particularly the growth of GP-led secondaries have been a driving force behind recent market growth. The demand side consists of parties eager to acquire secondaries positions. The demand for secondaries investment opportunities is currently high, thanks to generally strong returns, a lower risk profile, and more liquidity due to a shorter investment horizon. Research by Bain shows that this is the only category in which even the fourth quartile delivers fully positive returns (see figure below). Within the secondaries market, GP-led secondaries have recently grown faster than LP-led secondaries and now take an almost equal share in terms of total annual transaction volume (see graph below).
Private equity secondaries transaction volume and assets under management ('AUM').
Source: Prequin (per january 2024).
1. Current asof Q3 2023
Will the growth of the secondaries market be sustained in the coming years?
We believe that the secondaries market will continue to offer ample opportunities for double-digit growth in the coming years, as the total PE market is much larger (and still growing) and the need for liquidity is undeniable. Furthermore, the GP-led market is becoming increasingly institutionalized, which promotes growth.
