Institutional investors looking to dip their toes into
private investments should look first to the secondary market
rather than funds of funds, investment advisory firm Cambridge
Associates recommends in a new report.
Interest in investing in private instruments like secondary
funds has picked up over the past year so much so that
its become a sellers market, with secondaries
raising a record $13.6 billion during the first quarter of
2017. That comes down to performance, according to the
Cambridge report, released Tuesday, which found that portfolios
with at least 15 percent allocated to private markets
outperformed peers that had less than 15 percent allocated to
[II Deep Dive: Its Becoming a Sellers Market for
Wading into private markets with little experience can be
difficult, according to Cambridge. Many allocators opt for a
fund-of-funds investment in which managers invest in a
diversified portfolio of fund managers on behalf of clients and
charge a fee to do so to gain exposure to investment
strategies, such as private equity, that are tricky to master
without experience and connections.
But choosing a secondary investment instead can offer
certain advantages, Cambridge says. Secondary funds purchase
existing positions in private funds from other limited partners
looking to exit their investments, for liquidity, portfolio
restructuring, or other reasons. Investing first in secondaries
allows allocators to see immediate cash distributions while
experiencing less overall risk, according to the report.
If youre starting a private investment
allocation, you want to be able to show that your efforts have
a yield thats viable, Alex Shivananda, senior
investment director at Cambridge Associates, tells
Institutional Investor. This is another way to be able to
do that. Your capital is put to work faster, and is able to
show returns earlier.
Shivananda adds that while the two funds types have similar
characteristics, secondaries will invest in funds that
have earlier vintage years, which means youll have more
Secondary funds usually take around seven years to return an
allocators full investment, which is unusual for
any private equity strategy and desirable for that
reason, according to Cambridge.
On average, in the first three years of a secondary fund,
approximately 19 percent of limited partner capital is drawn
down. This is compared with 7 percent for traditional
private-equity funds and 4 percent for funds of funds, the
And this larger distribution lasted overtime. In years six
through eight of a secondary fund investment, 80 percent of
capital was distributed. For funds-of-funds, just 44 percent of
capital was distributed. In other words, secondary funds have a
much shorter life cycle than funds-of-funds.
Whats more, secondary funds overall report stronger
results that funds-of-funds, according to the Cambridge report.
Secondary funds often dont have to put nearly as much
money down as do funds-of-funds, according to Cambridge. At any
point within the funds lifetime, the maximum
out-of-pocket exposure for a secondary fund investor is 56
percent of investor capital. For funds of funds, its more
like 63 percent, according to the report.
Still, funds-of-funds remain a preferable investment in some
instances, Cambridge says. Venture capital, for instance, is
hard to access via the secondary market, according to the
report. Funds of funds are also useful for accessing emerging
markets, the report noted.
Still, Shivananda said, a secondary fund is a good option
for new investors.
The benefit of a secondary fund investment is that
allocators get cash back faster, he says. It
provides a benefit for the program manager in terms of showing