How well capitalised is the secondaries market?

Money continues to flow into what many say is the most undercapitalised corner of private markets.

Against a backdrop of one of the most gruelling fundraising markets ever, the secondaries industry raised a record $117.92 billion last year across asset classes, per Secondaries Investor data.

Lexington Partners and Blackstone Strategic Partners both smashed the $20 billion barrier, leading more than 90 funds in total that reached final closes in 2023.

And the consensus is that secondaries’ growth trajectory is set to continue. After all, this remains one of the most chronically undercapitalised corners of private markets, with little more than a year’s worth of dry powder estimated to be available, despite these superlative fundraising efforts.

“This is still an undercapitalised industry relative to the size of the opportunity,” says Immanuel Rubin, a partner and head of European secondaries at Campbell Lutyens. “We are only seeing the turnover of a small proportion of what’s in the ground.”

More than half (59 percent) of respondents to Private Equity International’s LP Perspectives 2024 Study intend to commit capital to private equity secondaries funds over the next 12 months, a proportion that has been steadily growing year on year.

“LPs commit to secondaries funds because they see that this is a materially undercapitalised market,” says Jan Philipp Schmitz, executive vice-president at Ardian. “Of the $200 billion or so of dealflow that we could have seen last year, only $120 billion-$130 billion transacted, because the capital just wasn’t there. That makes this a buyer’s market, and investors recognise that.”

Indeed, according to Ryan Cooney, a managing director at Hamilton Lane, investor allocations to secondaries have generally increased from 5-10 percent a decade ago, to closer to 20 percent today. “In some cases, that increase has been taken out of primary allocations. In other cases, investors have been reducing public equity exposure,” he says.

In part, this is due to the powerful forces driving secondaries dealflow today. “This is a strategy that prospers in times of volatility, dislocation and distress,” says Edward Holdsworth, a managing director at HarbourVest Partners. “In today’s environment, we are able to buy high-quality assets at wider discounts, which is extremely attractive and resonates well with investors.”

But far from merely a cyclical phenomenon, the secondaries market is in long-term growth mode. “The last three years have been the first with transaction volume of over $100 billion per annum. This is an asset class that is on an upward trajectory,” says Gordon Appell, a managing director in the private capital solutions group at PJT Park Hill. “That is attracting new pools of capital looking to get into private markets in a way that offers vintage year diversification and J-curve mitigation. For retail investors, secondaries make a lot of sense as well.”

In fact, one of the most transformative trends to impact secondaries fundraising is likely to be the democratisation of private markets. “Private wealth investors like the idea of gaining access to private markets through a diversified, lower risk strategy like secondaries, as well as buying an appreciating asset at a discount,” says Cooney.

It is still early days, however. “The retailisation journey is still in its infancy,” says Holdsworth, “but the secondaries market is resonating well with this pool of capital, given its low loss ratios, J-curve mitigation and diversification.”

Democratisation could also further fuel secondaries dealflow. “We believe the democratisation of private markets could increase the penetration rate of secondaries as a percentage of AUM from where it sits today in the low single digits,” says Shane Feeney, a managing director and global head of secondaries at Northleaf Capital Partners. “Retail investors are likely to have a greater need for liquidity than institutional investors, and secondaries can play an important role in facilitating that.”

Changing shape of the market

Growth in fundraising is also being driven by a proliferation of strategies as managers diversify into other asset classes, including infrastructure and private debt. Secondaries has historically been dominated by a small number of large players, however, and the expectation is that the majority of capital inflows will continue to go to those established names. But not exclusively.

“The retailisation journey is still in its infancy but the secondaries market is resonating well with this pool of capital”

Edward Holdsworth
HarbourVest Partners

“Big funds will continue to get bigger, undoubtedly. But we are also seeing quite a few entrants, particularly in the single-asset GP-led space,” says Rubin, pointing to buyout platforms that are looking to leverage their exposure in the continuation vehicle space.

Firms that have made this move include TPG and Astorg. “I expect more of this to come,” Rubin says.

“The single-asset GP-led market is where we expect to see high growth,” adds Holdsworth. “This is the most undercapitalised opportunity set within secondaries, given that generalist secondaries funds are restricted in how much exposure they can have to these deals.”

Entrants on the LP secondaries side are expected to be limited, however. “Barriers to entry are high. This is a difficult market to break into,” Rubin explains. “The big players have the coverage and setup to be able to transact in a fast and efficient manner. That isn’t easy to replicate.”

Ardian’s Schmitz agrees: “You need to have big teams and big databases in order to buy large LP portfolios with 100 funds and perhaps 1,000 underlying portfolio companies. Importantly, in our opinion, you also need to be investors in these funds. This isn’t like the public markets. You can’t get information from one of the well-known data providers. That is why I really don’t see there being many, if any, new entrants in this space.”

“Big funds will continue to get bigger, undoubtedly. But we are also seeing quite a few entrants, particularly in the single-asset GP-led space”

Immanuel Rubin
Campbell Lutyens

Yet PJT’s Appell points to more artificial intelligence-enabled, data-driven entrants looking at the LP-led space. Some asset managers are also attempting to circumnavigate barriers to entry by buying fully formed secondaries teams. CVC Capital Partners acquired Glendower Capital, for example, Franklin Templeton acquired Lexington and Ares Management acquired Landmark Partners. The trouble is that asset managers are running out of firms to buy.

“There just aren’t that many independents remaining,” says Rubin. “I think firms that have yet to secure a secondaries business will be scrambling around trying to figure out how to get hold of [one]. No doubt, we will see more M&A as groups try and buy up those last few standalone secondaries outfits.”

Appell, meanwhile, says that, while a lot of groups have already been purchased, there are still opportunities if asset managers are willing to think broader, potentially acquiring combined secondaries, fund of funds and co-investment businesses. “There are certainly some firms out there with $30 billion-$40 billion in AUM but without the broad distribution capabilities needed to scale further. My sense is that this could be a logical route forward for large multi-strategy platforms wanting to get into the secondaries space and questioning whether to buy or build.”