Everything You Need to Know About the Booming Secondary Private Equity Market
The secondary private equity market experienced exponential growth during the second half of 2023, reaching a record transaction volume of $67 billion, according to *L’Agefi*. Secondary funds offer a strategic opportunity to capitalize on the benefits of private equity.
Understanding Secondary Funds in Private Equity
Private equity involves investing in unlisted companies at various stages of their development. When an institutional investor, such as a pension fund or an insurance company, invests in a private equity fund at its launch, it typically commits to a long-term horizon, often 8 to 10 years.
Two Types of Transactions in the Private Equity Secondary Market
Transactions in the private equity secondary market can be initiated by two types of participants. On the one hand, there are Limited Partners (LPs), who are investors in a fund seeking to sell their stake on the secondary market. On the other hand, there are General Partners (GPs), who are the managers of private equity funds. GPs may wish to retain a company in their portfolio while allowing their investors to sell their stake in that company.
The Benefits of Secondary Funds in Private Equity
Secondary funds offer several significant benefits. First, they offer an attractive valuation thanks to an illiquidity discount in exchange for the liquidity provided to the seller. Second, they provide greater visibility and reduced risk, as they acquire shares in portfolios that have been in place for several years and consist of mature assets. This allows for a more reliable assessment of expected returns.
In addition, secondary funds offer a faster return on investment. The maturity date of the underlying fund remains unchanged when the shares are transferred, which reduces the holding period and maximizes the Internal Rate of Return (IRR). They also help mitigate the “J-curve,” which refers to the tendency of private equity funds to post negative returns early in their life cycle—a period during which the portfolio is being built and management fees weigh on the fund’s valuation.
Finally, secondary private equity funds provide faster access to a diversified portfolio of investments. A secondary fund may hold several hundred companies, compared with about ten for a primary fund. Because of this diversification, secondary funds offer a very good risk-return profile.
How Can Retail Investors Invest in the Secondary Market?
Secondary funds offer an attractive opportunity for investors looking to diversify their portfolios, particularly for those seeking their first exposure to private equity. They are accessible through various vehicles, such as life insurance policies, retirement savings plans (PER), or securities accounts. In addition, certain investment platforms specializing in private equity offer an expanded selection of secondary funds.
