In the past, private equity has been a mostly illiquid marketplace, with institutional investors buying into buyout funds and often having to wait more than ten years to reap the rewards. The PE marketplace was designed for investors to buy and hold assets, not sell for a quick return. Then the 200809 financial crisis occurred, and distressed sellers flooded the market, setting the stage for a new era in the business.
As a result of the crisis and more recent market volatility, investors now have the desire to access liquidity and the ability to rebalance their portfolio across asset classes. This need has fueled the emergence of a secondary market in which investors can sell or buy commitments to private equity, rather than just waiting it out for a return. As in the traditional equities market, the seller of a PE stake can tap liquidity in the secondary market, while the buyer gets access to private equity funds and diversification. Last year secondary volume moderated to $40 billion, making it the second-most-active year in secondary market history.
Why did it take so long for the secondary market to emerge?
One of the reasons is that there had been a stigma attached to limited partners who bought secondaries. Over time, that stigma has all but vanished. In fact, a recent report from SEI, a U.S. asset management advisory firm based in Oaks, Pennsylvania, reported that 58 percent of LPs acknowledged having bought or sold assets on the secondary market.
Despite the rapid growth of the secondary market, there are only a handful of specialized brokers globally facilitating the exchange of LP interests and building a secondary marketplace. This deficit is a problem and creates a need for qualified advisers, since the complexity of the business accentuates the need to have a strong administrative backbone to monitor all of the transfers of interests and reporting that are necessary.
Its important for investors to work closely with their consultants when deciding which secondary funds to invest in. In the past, secondaries were often distressed sellers trying to rid themselves of poorly performing assets. Now buyers are targeting more mature assets, which have track records.
According to research released this year by Boston-based Bain & Co., the number of nontraditional buyers in the secondary market a group that includes conventional LPs looking to bolster their private equity allocations has nearly doubled since 2013, to 485 in 2015. But investors arent the only ones taking notice of the burgeoning market. Big buyout houses are seeing the need and feeling the pressure to service the secondary markets as their own LPs seek to get out of investments for a number of reasons, including securing liquidity. Although there are a limited number of advisers in the secondary market right now, their ranks seem certain to grow as the market grows more popular.
For the first time, private equity investors can realize profits in the short term, through the use of secondaries. As the secondary markets provide more liquidity and options for investors, its a good bet that the market in private equity is here to stay.
Cesar Estrada is senior managing director and head of private equity fund services at State Street Corp. in New York.
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