many major asset managers to expand their business in the area .
Diversification
Secondary funds are generally more diversified than primary private equity funds ( such as growth equity or buyout funds ) because they are taking over existing investments from multiple funds . That allows them to offer a number of different managers , industries , geographies , strategies and vintage years . The advantage is that they give investors private equity exposure with less risk than an investment in a single primary private equity fund .
The ‘ J Curve ’
Secondaries also help investors with another important problem facing primary PE fund investors — the long time they have to wait to have their capital returned . Capital in the primary markets can take three to five years to source and complete deals , which means it can take several years before investors start receiving distributions . Secondary funds , on the other hand , invest faster and in underlying funds that are generally in their fifth year of life , which allows faster capital deployment and return .
EXHIBIT 1
Secondary Capital And Activity ( In Billions )
This difference in timing helps lessen what observers refer to as the “ J curve effect ,” or when primary funds typically have negative returns in the first few years . Since primary fund investors have to pay management fees and other investment costs from the outset , they start to see positive returns — ones big enough to meaningfully outweigh fees and expenses — only as the underlying investments mature over the longer arc of their lives . Secondaries , with their shorter time frames , help investors avoid that problem .
■ Dedicated Available Capital ■ Secondary Volume ■ Capital Overhang Multiple
$ 300B
$ 250B
$ 200B
$ 150B
$ 100B
$ 50B
2.2x
$ 125
Transaction Value In Billions
$ 58
$ 192
2.6x
$ 74
$ 155
1.8x 1.8x $ 188
$ 88
0
2017 2018 2019 2020 2021 2022 2023
Source : Jefferies , Global Secondary Market Review , January 2024 , Preqin . Note : Leverage estimated as approximately 15 % of equity dry powder plus near-term fundraising . Capital Overhang Multiple defined as Dedicated Available Capital divided by Total Secondary Volume .
3.1x
$ 60
$ 236
$ 132
2.1x $ 255 2.3x
$ 225
$ 108 $ 112
Discounted Access To Private Equity Funds
Investors in secondaries can also enjoy discounts on the net asset values in these funds , something that likely offers them a margin of comfort . Primary fund investors who want to exit funds or individual investments early might need to do so only by taking a cut in price — which works to the advantage of secondary buyers or fund managers buying the assets at a discount . The latter can get a boost from the markup of discounted purchases , which can boost their overall return .
Though the pricing on these assets varies and the discounts may not always be there , the trend line has been in investors ’ favor . Since 2017 , sellers have sold assets at an average of 88 % of their net asset value , according to the 2024 Jefferies report . Even when markets are robust with healthy deal activity , discounts are common . In 2021 , for example , Jefferies says the average secondary market pricing was 92 % of NAV .
Other Considerations
Some secondary funds focus on acquiring assets at later stages of their maturity , which means they miss the initial value creation enjoyed by the primary private equity investor . Other funds may get involved earlier in an investment ’ s life cycle to gain exposure to more growth uplift . But both approaches can enjoy the value creation uplift — even if it ’ s captured at different stages .
When markets are robust with healthy deal activity , discounts are common . In 2021 , for example , Jefferies says the average secondary market pricing was 92 % of NAV .
Investors evaluating secondary funds should remember that deal sourcing is important and that managers with a broad platform ( including primaries or co-investment platforms ) can often benefit . As with any private equity investment , manager selection is critical to realize the benefits of these strategies .
For investors ready to access private equity , secondary funds can be an appealing pathway . Both primary and secondary funds have a role in the private equity universe , and investors who recognize the unique attributes of both can establish baseline risk / return expectations to better incorporate private equity exposure within a portfolio .
KUNAL SHAH is head of private asset research and model portfolios at iCapital .
FLORENCE LEUNG is senior vice president on the research and education team at iCapital .
Full article available at icapital . com / insights
JUNE 2024 | FINANCIAL ADVISOR MAGAZINE | 37