A maturing secondaries market may help address some of the historic challenges preventing defined contribution retirement plans from investing in private equity.
In early December, Partners Group became the latest alternatives manager to launch private equity products aimed at the defined contribution (DC) pension market.
Discussions around how to make private equity available for DC plans have taken place for several years. On paper, it’s a win-win situation for all parties. Participants in 401k plans can have access to a higher-return asset class. PE firms can tap a broader set of investors, and retirement consultants and plan managers can diversify their offerings to participants.
But building a private equity programme that achieves the desired diversification can take a long time. And private equity is an illiquid asset class that’s difficult to value, which is hard to marry with 401ks that require investments to be liquid and priced on a daily basis.
A maturing secondaries market, however, is now able to address some of these hurdles in a way that wasn’t possible just a few years ago, when selling limited partnership stakes still carried a certain stigma.
Secondaries funds are effectively the best product a DC plan could buy considering they shorten the J-curve and bring immediate diversification of vintages, strategies and geographies. Additionally, as more limited partners focus on rebalancing their portfolios and feel more comfortable tapping the secondaries market, the quality of investments available for sale is going up.
A number of big secondaries players, especially those with large funds of funds platforms like Partners and Pantheon, have accumulated exposure to so many GPs that they can readily monitor hundreds of funds and their portfolio companies. This has positioned them well to build dedicated valuation teams and proprietary valuation processes that are needed for DC plans’ portability, valuation and redemption requirements.
Other secondaries firms with exposure to hundreds of underlying funds could develop capabilities to compete in the DC arena, too, while large alternatives houses like KKR are expected to continue to trial retail-focused offerings as public pensions gradually shift to DC plans.
It’s still way too soon to say whether the DC products and methods being developed by private equity participants today will indeed gain ground. And to be sure, there are sceptics out there – notably around the daily valuation issue – but expect more experimentation in this area in years to come. And, if our prediction is right, for the secondaries specialists to lead the way.
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