Q: Are the assets that LPs (limited partners, or investors) sell to secondary buyers of lesser quality? Why would someone sell good assets at a discount? And are there any numbers you can show to prove it?
— Nationally recognized Omaha Financial Advisor
A: The answer, thankfully, is that the quality tends to be high. Otherwise, there likely would not be much of a secondaries market.
There are many motivations for investors who need liquidity and look to sell their private equity stakes:
- Rebalancing: this could be due to public market declines that push the private market allocation over the LP’s investment policy statement
- Liquidity: private market distributions that LPs expected have not materialized, while capital calls keep coming in and the LP needs the cash OR private market distributions that LPs expected have not materialized but LPs want to commit to the next vintage of funds and need the cash — both of these situations happened most recently in 2023
- Portfolio organization: “cleaning up” older funds that are more than 10 years old and creating line-item proliferation in the LP’s portfolio
- Idiosyncratic investor issues: this could include a crisis at the LP, the need to pay for large expenses or a change in the investment team approach
In other words, the reason for a sale is almost never about the private equity assets; it’s about the seller.
Generally, LPs are incented to sell high-quality assets for which they can fetch higher prices. It’s typically easier to find willing buyers for good assets. LPs also find it more palatable to sell a quality asset for 85 cents on the dollar that is up 2x rather than a struggling asset for 50 cents on the dollar that is showing a loss.
One way to see the proof of these incentives is to look at the returns of secondaries vs. regular primary private equity funds.1
Risk and Return Analysis (by Market Capitalization)
A few things become apparent in the chart:
- Secondaries had similar returns to primaries (as measured by net internal rate of return (IRR))! This should help make the case that secondaries buyers are not taking lower-quality assets.
- Secondaries can frequently provide returns with less risk. We believe this is partially because they are not taking riskier lower-quality assets and partially because of their diversification benefit and the elimination of blind pool risk (more underlying holdings, you know what you’re buying, allows repricing for assets in real time).
- We show net IRRs for secondaries and primary buyout funds over 5, 10 and 20 years to show there is no time frame bias.
The data are consistent with our belief based upon 30 years of experience that secondaries are a representative mix of all buyout private equity and just as high in quality.
