Secondaries landscape may narrow due to LP sophistication

LP sophistication and secondaries’ increasing specialisation is drawing more capital to the market – a trend that is expected to continue throughout 2024.

Partners Group anticipates LPs will deploy “significantly more” into secondaries this year, according to Ross Hamilton, a managing director at the firm. Hamilton also expects the year ahead will be “one of the strongest vintages, given secondaries have historically outperformed following periods of dislocation”.

He adds: “With large secondaries volume available at attractive prices and favourable economics, LPs will not want to miss out.”

Given the slowdown in M&A, which market participants also expect will continue into 2024, LPs are thinking about other areas where they can get cash to work, Catherine Badour, partner and head of investor relations at Hollyport Capital, tells Secondaries Investor.

“Secondaries is one of the strategies that deployed significant amounts of capital in the last two years,” Badour says. For investors that are concerned they’re not putting enough capital to work – a concern that is particularly acute for LPs with younger programmes – secondaries is an area “where they’re seeking that additional support to just get drawn dollars out the door”.

Several mega-raises secured significant amounts of LP commitments in 2023. According to Secondaries Investor data, secondaries funds that invested in private equity opportunities were on track for a strong fundraising year in the first three quarters, with funds that held their final close between January and end-September raising $67.7 billion between them – a 168 percent jump on the same period a year prior.

Firms including Ardian, Lexington Partners and Carlyle‘s AlpInvest remain in the market with substantial raises, Secondaries Investor data shows.

While there could be a lull for secondaries fundraising following the close of large flagships, raises have been taking a considerable amount of time given the harsh fundraising environment. As a result, managers could return to market sooner than they historically have, according to Immanuel Rubin, head of European secondaries at Campbell Lutyens.

Hollyport saw heightened interest from LPs last year, particularly from endowments, foundations, family offices and other investors who do not currently have an allocation to secondaries, Badour says. “What’s driven that is the fact that people are looking for the consistent risk-adjusted returns and diversification that you can get from private equity secondaries.”

Likewise, private wealth investors and family offices have embraced the secondaries market, says HarbourVest Partners managing director Valérie Handal. While the secondaries market offers an attractive way to build out private equity portfolios, private wealth investors are also attracted to the velocity of capital coming back when investing in secondaries. “You’re investing in private equity, but you’re getting your money back quicker than if you were investing in a buyout fund,” she explains.

LPs are becoming increasingly sophisticated in their approach to secondaries, market participants note. “People are way more educated,” says David Atterbury, a managing director at HarbourVest. “It’s gone from being a tool used by people when they’re in the early stages of building their portfolios to mitigate J-curve, to being a tool for managing their annual allocations… It has a certain slot.”

Specialisation growth

Secondaries firms’ specialisation also offers more choice to LPs looking for compelling narratives from the buyers they are due diligencing.

The fact that LPs are coming to secondaries firms with very specific questions about differentiation “is evidence that investors are looking for more… than just the traditional secondaries market benefits, such as J-curve mitigation”, says Badour. “Investors are asking more questions and becoming increasingly sophisticated in the way they diligence secondaries funds.”

Investors are being offered a broader range of strategies, says John Carter, managing partner and CEO of Hollyport. These range from a “big index play” to niches where buyers have conviction they can generate outperformance – a trend that will continue over the next 12 months and beyond, Carter adds.

GP-led secondaries, meanwhile, is an area that market participants have a keen eye on. “As earlier vintages mature, continuation vehicle exits and realised returns will determine future fundraising momentum and investor appetite for new vehicles,” Partners Group’s Hamilton says.

Rubin agrees. He notes that, while these funds have been difficult to raise in recent years, there is certainly more specialisation in GP-led strategies, which is “probably going to be fairly central to how that market develops”.

The next year will see more players getting into credit secondaries, Rubin adds. Secondaries firms will continue to extend their offerings and launch such funds, while more traditional asset managers and credit firms are also seeking to launch their own credit secondaries strategies. Infrastructure, meanwhile, continues to be another growth sector for secondaries strategy expansion, he explains.

This increasing sophistication and specialisation will create an environment of “survival of the fittest”, Carter predicts. Certain managers will demonstrate they can deliver value from specific strategies, attracting an increasing amount of capital. Those that do not offer something special will struggle.

“I expect we will see a narrowing down of the number of secondaries operators because so many people have tried to come to the market over the last few years… but not all of them will survive in this increasingly competitive environment,” he adds.