The Importance of Private Equity Secondaries Funds as a Stepping Stone to the Secondary Market

by Scott Gibbs

  • 27 May 2015
  • PE

The private equity secondary market provides benefits for both buyers and sellers. In recent years, the industry has witnessed an increasing number of transactions, providing some liquidity for investors in what is considered one of the most illiquid asset classes. There are undoubtedly benefits to buying fund stakes on the secondary market, the most significant being the ability to mitigate the J-curve, resulting in many investors now looking at these opportunities. For the less sophisticated investors, the best way to access the private equity market is through secondaries vehicles managed by secondary fund of funds managers, which provide a suitable stepping stone to directly buying stakes on the secondary market.

Preqin’s Investor Intelligence online service currently tracks 5,828 investors that invest in, or are considering investing in, private equity funds. Of these investors, 1,321 (23%) show a preference for secondaries funds. As the chart below illustrates, this percentage has increased slightly year-on-year since 2011, when only 18% of investors exhibited a preference for secondaries vehicles.

Twenty percent of investors with a preference for secondaries funds are public pension funds, followed closely by private pension funds (19%) and foundations (16%). In terms of regions, unsurprisingly, North America-based investors lead the way, home to 63% of investors with a preference for secondaries funds, ahead of Europe-based investors, which make up 22%. However, of the total number of investors that Preqin tracks, 54% are based in North America, showing a proportionally higher percentage of North America-based investors favouring secondaries vehicles, likely due to the more sophisticated North American investor landscape. 

According to Preqin’s Fund Searches and Mandates module, it is evident that investors will continue to invest in secondaries funds over the next 12 months. Eleven percent of those investing in the next 12 months are targeting the fund type, with 64% targeting Europe-focused funds and 65% targeting North America-focused funds. Emerging markets are also more attractive among those favouring secondaries funds in the coming year, with 25% of investors willing to invest in these regions, above the average of 21% for all investors investing over the next 12 months.

Therefore, it remains likely that the secondary market will continue to grow as it provides a vital exit opportunity for private equity investors looking to offload their fund interests, which could be for a number of reasons, including to raise capital or to alter their allocation to the asset class. Simultaneously, this supply is met by increasing demand from secondary fund of fund managers seeking to buy into funds, again for a number of reasons, such as to anticipate positive cash flows as soon as possible, or to be able to fully evaluate the performance of a portfolio before investing. Secondaries vehicles will become an evermore important fund type for LPs, as it provides an opportunity to buy assets at discounts to NAV and gain access to previously oversubscribed funds, serving as an effective tool for portfolio management.

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