How big can secondaries funds get?

A secondaries fund is set to rank among the largest PE funds ever, and dealflow continues to soar; but don’t expect growth to be unconstrained.

This week, Secondaries Investor has been on the fringes of SuperInvestor in Amsterdam, collaring any limited partner that walks by. Some expressed doubt about the future returns of mega buyout funds, questioning whether high entry values combined with the fees made them worth the illiquidity.

Some of the most common complaints about mega buyout funds don’t necessarily apply to secondaries funds, however. Buyout investors want to see big multiples on exit; the larger a fund, the more difficult it is for a deal to move the needle. As secondaries investors prize early, steady cashflows, surely a highly diversified fund such as Ardian’s ASF VIII could tick along just as well at $20 billion as it does at $12 billion? (The fund is seeking up to $18 billion in total).

According to data from Hamilton Lane, secondaries deal volume over the last 12 months was around $150 billion, a 50 percent increase on the year before. Still, secondaries deals only represent around 2 percent of all private equity net asset value: “There has been growth, but in the context of dealflow there remains capacity for these funds to grow,” said the firm’s managing director Richard Hope.

There are limiting factors. First, there is capacity to process dealflow. While easier than it was, the trading of LP stakes is hardly a commoditised business, particularly when dealing with new or obscure funds, or funds that are outside a secondaries buyers’ sweet-spot. Then there are GP-led deals, and all the complexities they entail.

If secondaries funds have gotten too large, it could also take away the quality control that has made the strategy a success. If a fund is limited in size, the secondaries buyer will have to be more selective. The portfolio will be more concentrated and hence riskier, but the return should be commensurate with that risk.

A massive fund would experience intense diversification, bringing down the pooled average return. This is partly because deals which buyers might pass up on today would end up getting done.

“[If a GP backs] one in three transactions, the question is ‘why did the two not happen?’ Was it a pricing point? Was it about the quality of the asset? If someone raises $90 billon for secondaries, are they going to somehow take some of these transactions that never happened and integrate them?” said Cyril Demaria, partner with research firm Wellershoff & Partners.

Would LPs want it? Perhaps one with a new private equity programme would love to write a big ticket to a secondaries mega-fund, giving them immediate, diversified exposure. But what about a more mature programme? Secondaries Investor has been told of one large pension fund which, having built its PE portfolio on secondaries, is now withdrawing from the strategy in favour or buyout, co-investments and private credit. There are others that view secondaries as one step on a journey elsewhere.

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