You’ve said that the secondaries market could reach $1 trillion in annual deal volume. How do we get to that figure and on what timeframe?
Simply put, I believe that the secondary market has the potential to grow to $1 trillion or more in annual volume by 2030. For me, the path to get there is simple. It comes down to two variables – the continued growth of private capital assets under management and the increase in the percentage of private capital assets trading annually. If you can believe that private capital grows at 10 percent a year to 2030 and that 5 percent of private capital AUM trades in any one year, you get there. Here’s how.
Start with increase in private capital AUM. We all have heard that public markets are shrinking and private markets are growing. There is no doubt that private capital has been on the rise. In 2016, there was $5 trillion in net asset value plus unfunded commitments in the global private capital market. From 2016 to 2019, it has been increasing at about $1 trillion per year or a 15 percent to 20 percent growth rate. By June 2020, this number was $8.5 trillion. If we assume more muted growth of 10 percent a year, we get to $14 trillion by 2025 and over $22 trillion by 2030.
On the second variable: in 2019, the secondary market traded on $80 billion. In fact it more than doubled from 2016 to 2019 from $37 billion to $80 billion. But when you look relative to the size of private capital AUM, we are talking about 1 percent of the private capital trading in any one year. 1 percent. Imagine this number were to grow to 2.5 percent by 2025 and 5 percent by 2030.
Combining these two variables, by 2025, a $14 trillion private capital market with 2.5 percent turnover results in annual secondaries volume of $350 billion. Fast forward to 2030, a $22 trillion market private capital market with 5 percent turnover would get annual secondaries volume to over $1 trillion.
When disaggregated in this way, what seems on the front of it to be a bold prediction may in fact be a conservative one. It assumes private capital AUM growth slows from 15 percent to 20 percent historically to 10 percent over the next decade and secondaries market turnover rate increases from 1 percent to 5 percent.
This will require increased market adoption for the market to move from 1 percent to 5 percent of the market trading in any one year. What will drive that?
First, on the LP side. One must believe that as private equity markets continue to grow and mature, investors will become more sophisticated in the way they manage their portfolios as they have done in public markets. If your public portfolio has too much exposure to one sector or one geography, rebalancing it is a common occurrence. We believe this will be a growing trend for investors in private equity. Institutions will start tactically reallocating their portfolios and actively managing them. As this trend continues to accelerate, this will spur ongoing and significant growth in the LP secondaries market.
Second, on GP-led transactions. The GPs themselves are becoming more sophisticated in the way they manage their funds. All the innovations around single asset secondaries, GP continuation funds, NAV-based loans, preferred securities at the fund level and GP balance sheet solutions will drive secondaries volume. These innovations have provided many more tools in the toolset for GPs. My sense is, fast forward 10 years from now, if GPs are not using these tools, they will have been left behind, just like operational value-add did over the past 10 years.
Third, asset class maturation. Private capital AUM includes asset classes like real estate, infrastructure and credit. As these asset classes mature, secondaries volumes increase. We are starting to see more focus on these sub-asset classes accessing the secondaries market.
Finally, evolution will continue to be the name of the game with a focus on injecting liquidity in an otherwise illiquid asset class. As other sources of capital seek to access private capital including defined contribution plans, high net worth and retail, we will see yet more growth in the secondaries market as these investors will have their own liquidity requirements.
What factors could prevent the market from growing to such a size?
Resources and capital. In that order.
I think what is grossly misunderstood in the growth of the secondaries market is that the constraining factor at this point is not supply. It is the fact that there are not enough resources dedicated to this space. Executing on secondaries is a highly nuanced strategy. From the outside, it may look simple. But to get it right and execute seamlessly, one needs experience. The more we build experienced secondaries ecosystem, the more the market will grow at even higher rates than we have seen more recently.
Ask any agent right now in a quiet moment about their pipeline and the response will be “we don’t have enough resources to deal with our pipeline and/or buyers are swamped, we compete for their attention.” Resources, not the opportunity set, is constraining growth of the market.
Capital will be the second challenge. But I worry less about this. As the market grows and investors understand the potential of this market, capital will flow.
If your prediction comes true, how do you expect this will change the market’s dynamics? What will secondaries funds and firms look like?
Secondaries will mature into a sub-asset classes just like buyouts did over time. In its infancy, buyouts were buyouts. Today you have mega, large, mid-market, growth and so on . You have sector-specific funds and geographic ones, all benchmarked differently. At some point, secondaries will split in the same way.
What is becoming increasingly apparent is that not all secondaries strategies are created equal. Single assets have the potential for higher returns, but with more risk. Structured solutions target lower returns but with less risk. As time passes, more investors will recognise this and there will be more focus on risk adjusted returns. No strategy is better or worse, it will depend on what your portfolio needs are and the manager you select to pursue it. In the end, secondaries will ultimately provide myriad different products with different risk return characteristics.
Yann Robard founded Whitehorse Liquidity Partners in 2015. Prior to that he spent 13 years at Canada Pension Plan Investment Board where he most recently was managing director, head of secondaries and co-investments.