Private equity cannot be liquefied as swiftly as equity bought off stock markets. That’s why, to enable smooth liquidity events a Private Equity Secondary Market exists where previously issued equity is bought or sold to new investors.
Launched in the 1990s, the Private Equity Secondary Market was the go-to option for limited partners to exit certain funds that were not performing up to their expectations. Today it has become a must-have for limited patterns who want control over their stake’s liquidity or reduce exposure to future capital class. This has made equity from funds that are performing well more accessible in the secondary market, just like one could find equity on recognised stock exchanges.
Now the demand to access private equity has steadily grown since the 1980s due to enormous profits that can be made by investing in companies that have not yet gone public and the long-term nature of private equity. In fact as an asset class, private equity went from having $2.4 trillion worth of assets under management to $6.5 trillion in 2020, according to an McKinsey’s annual review. While the increased growth could be attributed to investors looking for higher returns, the secondary market itself has grown rapidly to $90 billion, a six-fold increase with buyers and sellers trading existing private equity funds.
One of the reasons why secondary markets have become robust spaces is that buyers are able to evaluate holdings of the fund before actually investing. From a risk point of view, secondary markets have relatively lower risk than traditional fundraising avenues. And though there is no ‘trading’ market per say for secondary markets, it still forms a very important part of private equity portfolios.
There are also other strategic reasons why investors might access secondary markets. This could include them wanting to rebalance their portfolios. Let’s say a limited partner’s portfolio holds 25 percent private equity and it performs better than other assets in the portfolio and can grow to 35-40% of the portfolio. In this case the investor might realise some of the gain in the secondary market to bring the overall portfolio breakup to the optimum level.
Investors could also be seeking to move investments around their portfolio. For instance they could be unrealised investments stemming from funds whose original term has ended. Investors might want to reduce exposure to such funds and increase their positions in environmental, social and corporate governance funds.
The secondary market gives investors the opportunity to subscribe to funds they might have not had the opportunity to during initial fundraising rounds.
The Private Equity Secondary Market is poised to expand with the high growth of private equity fundraising. This has also increased the checklist of what’s for sale in the secondary market. This has diversified to include stakes like private debt funds, pension funds, real estate and infrastructure in addition to more traditional private equity stakes.
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