Definition of the Month: Private Equity Secondaries
Meet Chukwunonso (“Nonso”) Ayalogu, a junior at North Carolina State University and AD Alumni Fellow. Nonso worked on the PE Secondaries team at Harbourvest last summer and quickly became fascinated with the industry. In this blog post, Nonso shares an overview of the world of PE Secondaries and why he finds it exciting.
Private Equity Secondaries refer to transactions in which a secondary investor purchases an existing interest from limited partners. The market is mainly divided into LP (limited partner) and GP-led (general partner) transactions, but other forms exist, such as direct secondaries and private credit secondaries.
In LP-led deals, a limited partner sells some or all of its stake in a fund or a portfolio of funds to a secondary buyer, who then becomes the new LP, as they take on the rights and responsibilities of the prior LP in the fund(s). They then become liable for capital calls and also benefit from distributions paid out. LP-led deals occur for several reasons, such as the seller needing liquidity, or wanting to rebalance their investment portfolio.
In GP-leds, with the most popular transaction being the Continuation vehicle, an asset(s) or portfolio company(ies) is transferred from one vehicle to another, offering the private equity firm additional capital and time for it to execute its value-creation plan. Existing investors are often given the option to cash out or roll over their stake into the new fund.
Benefits of Secondaries:
Mitigation of the J-Curve Effect: The J-curve refers to the typical pattern of returns for private equity investments. The pattern shows initial negative returns followed by positive returns in later years, which is a representation of the process of investing capital and creating value. By entering at a later stage in a fund’s lifecycle, secondary investors can potentially avoid the initial negative cash flow period
Diversification: Secondaries provide the opportunity for investors to diversify their investment portfolios by gaining access to a range of assets across managers (general partners), geographies, industries, strategies, and vintages
Lower blind pool risk: Primary funds tend to commit capital with limited visibility as to how the private equity fund will deploy it. Secondary funds, on the other hand, can analyze the existing holdings in a fund’s portfolio and make more informed investment decisions.
Major players in the Secondary market include Ardian, Blackstone Strategic Partners, HarbourVest Partners, Coller Capital, Lexington, and AlpInvest.
Why I love Secondaries:
Last summer I interned at HarbourVest and became captivated by the world of Secondaries. The work is super interesting! I loved working on the GP-led processes (Continuation vehicles, in particular). The diligence process involves analyzing assets thoroughly, conducting expert calls, projecting returns, and making informed investment decisions, which I find incredibly fulfilling.
LP-led processes are also fascinating - you get to analyze various funds and the underlying portfolio companies. The ultimate goal is to arrive at a value for the fund/portfolio of funds, and they tend to price at a discount to Net Asset Value ( GP-leds can price at a discount as well but on average, discounts are much lower, and they price at par or above par more often than not - it essentially depends on the quality of the assets amongst other things) The secondary market continues to exhibit massive growth, achieving a 16% CAGR over the past 10 years. Recent transactions in the space that you can dive into include:
HarbourVest’s acquisition of the $1.2bn Cathay Life portfolio
Permira’s multi-asset CV backed by Ardian, Coller, and Glendower
Wellspring’s multi-asset CV backed by Lexington, Neuberger Berman
