* Top-Down protection: Secondaries fund managers benefit from buying in remaining portfolio assets. That gives them a good visibility of the portfolio’s underlying sectoral and geographical exposure as well as the historical performance of the remaining assets.
**J-Curve: The term J-curve is used to describe the typical trajectory of investments made by a private equity firm, that typically shows an initial decline in performance followed, at least theoretically, by a steep improvement in performance.
***Greenhill & Co. – Global secondary market Review 2021
It was back in the 1980s, when a handful of firms started selectively purchasing Private Equity interests in leveraged buyout and venture capital funds. It took the market almost two decades to develop from a niche market – characterized by scarce liquidity, few buyers, distressed sellers, and significant discounts to NAV – to a functional and active marketplace featuring meaningful transaction volumes and numerous market participants, including brokers. Four global recessions and thirty-seven market corrections later, Secondaries as an asset class are perhaps considered the best win-win in Private Markets. It is not only the diversification of the portfolios, the top-down protection*, and a mitigated J-curve**, but as companies remain private longer, Secondaries are also providing liquidity in an illiquid market by definition.
And while, according to Greenhill***, in 2020 volumes fell to USD 60 billion from a record USD 88 billion in 2019, third and fourth quarter’s volume of USD 42 billion was only marginally below the USD 46 billion recorded for the same period in 2019. The decline in volumes was primarily driven by the halt in transaction activity in the second quarter as well as the dearth of large LP portfolios. On the other hand, the regain in market confidence has not been broad based. Buyers’ focus was primarily on assets in “COVID-proof” sectors, newer vintage funds, and more concentrated exposures, which are easier for due diligence and to underwrite.
But what does the future hold for Secondaries? The COVID-19 crisis has, in fact, altered the fairly limited view on managing private equity portfolios. As distributions have lagged behind expectation, many new LPs were spurred on to use the Secondaries market to accelerate liquidity and returns to the point they had targeted prior to the pandemic. On the other side of the equation, many new Secondaries players are seeking a slice of the action in a growing market that is allowing Secondaries firms to differentiate. Whether it’s GP led LP transactions, Restructuring, Single Asset Continuation Vehicles or Preferred Equity, the outlook for 2021 looks very encouraging, making the search for the right manager even more adventurous for investors.
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