Private equity secondaries in focus. As financial sector stresses and the public market sell-off of 2022 has dented risk appetite around equity capital raising and business acquisitions, private equity (PE) markets are increasingly finding it difficult to pursue the usual exit strategies around IPOs or trade sales. As such, attention to the PE secondaries market is expected to rise as a means of recycling capital. Although secondaries constitute a relatively small share of c.5% of PE AUM, this space is expected to gain prominence given the dynamism it provides to the private market ecosystem.
Such trends are positive for investors looking to gain exposure into PE, given that (a) the improved dynamism and volumes of PE secondaries would ease the tradability of a traditionally illiquid asset class, and (b) open the road to more fairly valued opportunities to invest in companies that are closer to their cashflow-generating stage, mitigating the need for large capital calls at the outset. We explore some of the other nuances of the PE secondaries market below.
PE secondaries broadly refer to transactions involving existing PE stakes. They are broadly categorised into LP-led secondaries and GP-led secondaries.
Benefits of PE secondaries. The benefits of the PE secondary market to existing investors are evident – Secondaries give LPs an exit ahead of a fund’s maturity and provide GPs flexibility to tweak asset holding periods and fund exposure. Aside from these, there are also salient features that make secondaries an attractive segment of PE for those seeking private asset exposure. Some benefits of investing in PE secondary funds include shorter investment duration and earlier return of capital than primary PE fund; lower investment risks; and dirversiftied private equity exposure. As evidenced by the growth of PE secondary AUM and larger secondary funds being raised, the LP community is recognising these benefits of PE secondaries investing.
Risks in PE secondaries investing. The flipside of unique benefits of PE secondaries is additional risk factors that investors should be mindful of. This includes complexity and hidden leverage in investment structures; potential conflict of interest; and liquidity risks.
Opportunities in PE secondaries despite uncertain macro environment. Amid a funding crunch, sponsors are increasingly looking to secondaries as a liquidity option, supporting the long-term prospects of the PE secondaries space. As most exit options are challenged and PE valuations descend from prior year highs, this is could provide opportunities for secondaries buyers to acquire exposure to high quality portfolios at a discount.
Although secondaries could provide PE investors a means of gaining exposure to high-performing private companies, caution is nonetheless warranted given the uncertain landscape. Investors would do well to understand both the business models of the underlying companies, and the investment structures used. This includes leverage, types of funds strategies, and sources of returns. As with other areas of private asset investing, we continue to emphasise investing through GPs with proven track records of investing through market cycles, the expertise to identify resilient businesses, and the network to access the best quality deals.
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