Fundraising boom as private equity secondaries market heats up

April 30, 2024 (Preqin News) – The private equity secondaries market is hot, with fundraising hitting a record $93.8bn last year, a 159% increase from 2022. LPs indicate that secondaries are top of their list of the most attractive private equity strategies over the next 12 months.

Nearly two-thirds (64%) of the LPs surveyed for Preqin’s Investor Outlook: H1 2024 said secondaries provide the best opportunity in private equity, making it more popular than both small- to mid-market buyouts (49%) and special situations (48%).

But as LPs who piled into venture capital in the heady days of 2020 and 2021 are finding out, jumping into a hot market is not always a recipe for investment success. So, what are the prospects for the secondaries market?

Although fundraising for secondaries has been rising steadily, there are peaks and troughs that depend on the fundraising cycles of the big players. Before last year, the previous record years saw $83.3bn raised in 2020, and $44.8bn raised in 2017.

There is no shortage of managers in the market, which comprises 181 secondaries and secondaries direct funds with a combined aggregate target of $129.9bn.

‘We’re seeing an uptick in interest in secondaries. Historically, it has delivered incredible returns over a long period of time – it’s the only alternative asset class where even the bottom quartile delivers a positive return,’ Hugh MacArthur, Chairman of the Global Private Equity Practice at consultancy Bain & Company, told Preqin News. ‘There’s definitely demand and I think fundraising will be up, but I don’t say that with a massive amount of confidence because secondaries tend to come out of the same pockets at LPs as other types of private equity, and they’re all cash constrained.’

But does a hot fundraising market mean there is an excess of supply? Roy Baumann, Managing Director at Switzerland-headquartered global private equity firm Partners Group – which had assets under management (AUM) of $147bn as of the end of 2023 – says it’s important to look beyond the headline figures. ‘The numbers show record fundraising last year, but the way they are counted is flawed,’ he told Preqin News. ‘A lot of the funds that closed and are in the 2023 numbers were open for two years and had already started investing. If the market remains active, I would expect dry powder to go down because new fundraising won’t be quick enough to cope with the deployment.’

A deeper dive into Preqin’s data verifies Baumann’s point. The average time in market of a secondaries fund that closed in 2023 was 23 months. Data on secondaries investments is a particularly opaque part of a generally opaque asset class; the $177.4bn of dry powder represents approximately one and a half years of capital the market would require to sustain the $100bn+ pace of annual transaction value over the past two years.

In its Global Secondary Market Review 2024, investment bank Jefferies estimates 2023 transaction volume at $112bn, a 4% increase on 2022, and forecasts robust growth for 2024, with volume likely to exceed $130bn. Jefferies put peak dedicated available capital at $255bn, based on a variety of data sources, including Preqin.

Last year the gulf between buyer and seller expectations was much discussed, including how it was making it difficult to get transactions over the line. However, participants point out that more than $100bn in deals were done for the second year in a row. Investment activity may not have hit its potential, but it was still one of the busiest years on record, with the bid-ask spread narrowing in the second half and activity picking up.

Capital supply may be increasing, but so is demand. ‘This is a market that, in our view, is one of the most undercapitalized within private equity, especially at the larger end where the number of buyers is quite reduced,’ Marie-Victoire Rozé, Deputy Co-Head of Secondaries and Primaries at Ardian, which has AUM of $164bn, told Preqin News. ‘There are very high barriers to entry, including needing a very large team, having relationships with a large number of GPs, and a global presence. This is not something you can build overnight. So, we feel the competitive landscape is quite reasonable.’

Baumann is less bullish but points to a significant change in seller motivation that is likely to work in buyers’ favor. ‘I think supply and demand are fairly balanced. I’d love to say secondaries are underfunded, but there is always competition,’ he said. ‘But there is more volume of supply. What’s changed is an increase in sellers who have a real need for liquidity or portfolio rebalancing – they want the best price they can get, but they will sell even if they don’t like the price.’

Consultancy Bain & Company devoted a chapter of its Global Private Equity Report to the secondaries opportunity, describing its market size as ‘puny’ relative to the rest of the industry. Hugh MacArthur believes the industry will find a way to scale: ‘We're seeing GPs jumping in on the buy side,’ he told Preqin News. ‘That’s a harbinger of a variety of new players coming into the secondary market. It would not surprise me at all to see entities like sovereign wealth funds jump directly into secondaries and expand the pool of people that are providing not only financing and flow into the market, but also doing the deals.’

While it’s likely that this will increase capital supply in the longer term, the impact of new entrants will not be felt immediately. Last week, fund manager Ares Management announced a $1.1bn deal to acquire a portfolio of private company stakes. Ares now has $24.7bn of AUM in secondaries after entering the space with the $1.1bn acquisition of Landmark Partners in 2021, one of the oldest and most established secondaries players with $19.6bn of AUM at the time.

Baumann says that while discounts are important, the main driver of value is identifying and buying assets with growth potential over a three-to-five-year horizon. ‘While the tailwind from a discount perspective will probably get a bit less, we have a better macroeconomic environment and can expect better growth in the underlying portfolio, which can more than compensate for the lower discounts,’ he said.

Players in the market are bullish on the growth prospects. ‘There is still huge growth potential for this market. The percentage of AUM that trades annually in the secondary market – anywhere from 1–2%, depending on the year – is very low compared with other asset classes,’ said Rozé. ‘In the long term, the secondary market will come to be seen as a tool to actively manage your portfolio at any point of time, anywhere in the cycle, and not just when there is dislocation.’

_{The opinions and facts included within the above do not constitute investment advice. Professional advice should be sought before making any investment or other decisions. Preqin providing the information in this content accepts no liability for any decisions taken in relation to the above.}