Within the private markets space, an area that’s grown in recent years is “secondaries” – buying and selling pre-existing stakes in private equity, credit, real estate, and infrastructure. Such markets encourage price discovery, and the promise of more liquidity makes investors feel more comfortable.
The following article comes from Steven Brod, the senior
partner, CEO and chief investment officer at Crystal
Capital Partners, a firm based in Miami, Florida.
The article draws a parallel between the ancient Silk Road
and modern private equity markets, particularly focusing on the
roles of secondaries and continuation funds. In particular,
Brod’s article highlights how secondaries offer early exits for
liquidity, while continuation funds allow the extension of
high-potential investments.
He argues that financial advisors must understand these
markets if they are to guide clients properly through changing
market conditions.
This article speaks to the continued trend of wealth
management interest in private market (equity, credit,
infrastructure, other) areas, a field that has boomed on the back
of cheap money post-2008, and a structural shift of corporates
away from listing on the public markets.
The editors are pleased to share these ideas; the usual
editorial disclaimers apply to views of outside contributors. To
respond, email [email protected]
From the second century BCE to the 14th century CE, traders
traveling the lengthy and perilous path from Asia to Europe,
known as the Silk Road, innovated by establishing trading posts
and intermediate markets along the route. They served not only as
rest and resupply stops, but also facilitated the exchange of
goods, allowing traders to cash out or continue on their journey
with new lucrative inventory. In the world of private equity,
secondaries and continuation funds serve a similar purpose:
secondaries funds offer early exits for investors who require
liquidity, much like the Silk Road’s trading posts, and
continuation funds provide a way to extend the journey of
high-potential investments without locking up capital
indefinitely.
As the Silk Road witnessed an increasing number of travelers, so
too has the private equity market experienced increased interest
in these types of funds. It is therefore important that financial
advisors, when serving as fiduciaries, understand these offerings
so that they can provide the best advice to their clients.
First, advisors must consider the private equity market more
broadly. Exit volumes have shrunk considerably, while managers
contend with record levels of dry powder and unrealized value.
Last year, global private equity exit value totaled only $575.8
billion, its lowest level since at least 2019, according to
Preqin (1), while global private capital has grown to
approximately $12 trillion in assets under management, nearly
double its 2019 amount, as reported by PwC (2). Against this
backdrop, private equity managers are considering ways to
optimize high-potential assets by extending their investment
horizons, and investors are seeking liquidity, exit strategies
and a quicker turnaround on invested capital.
The secondaries market has evolved into a sophisticated arena for
portfolio management, with the market increasing 7 per cent to
$60 billion in 2023, according to Jefferies Financial Group (3).
But how should advisors analyze the aforementioned dynamics with
respect to advising their clients? Secondaries funds, which
typically consist of more mature assets with potentially lower
risk profiles, may provide more predictable and stable return
streams. These assets often come with established performance
histories and the initial dip in return an investment experiences
(a function of the J-curve effect) is typically less pronounced.
As these investments are more mature, they can offer nearer-term
liquidity compared with traditional private equity funds,
which can be attractive for clients looking to realize
investments sooner.
Continuation funds, used by managers to roll over assets from one
fund to another within the same firm, are seeing a similar rise
in popularity. This is partly due to robust performance.
These funds have earned a median of 1.4x multiple on invested
capital, on par with secondaries funds and higher than the median
1.2x from buyout funds, according to Morgan Stanley (4). There
are several potential benefits for advisors’ clients. There is
the opportunity to invest in well-vetted companies that GPs have
strong confidence in, given their willingness to extend the
holding period. Continuation funds may therefore also provide
access to high-potential assets that have a clearer path to
liquidity and more defined exit strategies.
Forward thinking advisors should always be cognizant of how the
private equity market is evolving. As the sector matures, the
volume of older funds will expand opportunities in the secondary
market, and newer asset classes and innovative investment
vehicles will likely enter the space.
Over time, firms and funds will become increasingly
institutionalized, adopting more formalized processes and
standardized practices. Additionally, technology integration,
especially in data analysis and transaction processing, will
enhance efficiency and transparency, while encouraging more
players to enter the space. Similar parallels can be seen in the
maturation of the Silk Road, where advancements in the medium of
exhange lead to the invention of paper money, making trading more
efficient, and ultimately facilitating greater commerce.
However, before allocating to a secondaries fund, advisors should
be aware that secondaries transactions are not usually general
partners’ first choice. They are often undertaken when managers
cannot execute on other exit strategies, such as initial public
offerings or strategic acquisition. This could be due to several
factors. First, it can be challenging to find buyers at desired
prices. Second, there is significant counterparty risk, as
transactions depend on the reliability and creditworthiness of
counterparties. Third, it can be hard to determine the fair value
of assets as there is less transparency and less frequent pricing
in secondary markets, as compared with primary ones.
For continuation funds, investors must similarly be wary of
accurate asset valuation, as the value of the assets being
transferred can be subjective and not reflect true market value.
On top of this, market or sector conditions may change
unfavorably during the extended holding period, impacting
portfolio companies’ performance.
Continuation funds also face operational risks, and the success
of the funds heavily depends on the skill and track record of the
funds’ general partners.
These risks highlight the importance of careful due diligence.
Advisors would be well served by engaging third-party specialists
who can help them research the top managers offering secondaries
and continuation funds, as this expertise is not often found
within financial advisory firms.
Advisors looking to navigate the complexities of private equity
investments should be aware of the way the industry has matured
in recent years and how it will continue to do so in the future.
For discerning investors, secondaries and continuation funds may
provide potential benefits with regards to diversification,
high-quality assets and liquidity/exit strategies. However,
understanding the specific associated risks of each strategy is
crucial for making informed investment decisions.
[1] S&P Global, Apr. 2024,
https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/private-equity-exit-value-sinks-to-3-year-low-in-q1-81247928
[2] PwC, Jan. 2024,
https://www.pwc.com/gx/en/services/deals/trends/2024/private-capital.html#:~:text=Private%20capital%20has%20approximately%20US,these%20investments%20to%20be%20exited.
[3] Global Secondary Market Review, Jan. 2024,
www.jefferies.com/wp-content/uploads/sites/4/2024/01/Jefferies-Global-Secondary-Market-Review-January-2024
[4] Kokalitcheva, Kia. Riding the Continuation Fund Trend in
Venture Capital. Axios, May 2024,
www.axios.com/2024/05/07/venture-capital-continuation-funds.
