Liquidity issues prompt greater LP interest in secondaries

As a growing number of LPs look to buy and sell private equity fund stakes in the coming months, Madeleine Farman asks whether there are bargains to be had.

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Investors are increasingly looking to the secondaries market to manage their portfolios. Twenty-two percent of respondents to Private Equity International’s LP Perspectives 2023 Study say they intend to sell LP stakes only – representing the largest portion of LPs to do so in the past five years. A further 6 percent plan to both buy and sell.

Private equity valuations have held up in recent months while public market valuations tumbled, culminating in the denominator effect for LPs.

“What this means is that some investors will have to sell part of their PE portfolios, but ultimately whatever is sold is most likely still going to be generating an attractive return for the LPs since inception,” says Lea Lazaric Calvert, senior managing director and head of Evercore’s European private capital advisory team. “This is not a situation where an asset class has performed badly, so investors are getting out of it. It’s the opposite – private equity has performed very well.”

“I’ve been in this industry for more than 18 years,” says Immanuel Rubin, partner and head of European secondaries at Campbell Lutyens. “I have never seen as much LP flow from institutions in Europe.”

18%

LPs that are most likely to sell their exposure in a continuation fund process

90%

LPs that believe mandatory independent third-party valuations are necessary in a GP-led secondaries process

Overallocation is one issue, but for some investors – for example, defined benefit pension schemes in Europe – there’s a de-risking task going on, he explains. “Historically, [these investors] were underfunded, and the way to address this is to seek risk and therefore higher returns. Now we’re starting to see an unwinding of that because they don’t need that level of risk anymore to get their pension plan to be funded.”

Interestingly, 30 percent of respondents plan to tap the secondaries market to buy fund stakes in the coming year.

“LPs are also not one homogenous voice” and some may be at different stages of growing out their private equity programmes or looking for different levels of exposure to certain asset classes, Lazaric Calvert says.

“I’ve been in this industry for more than 18 years. I have never seen as much LP flow from institutions in Europe”

Immanuel Rubin
Campbell Lutyens

If investors don’t have pressure to reduce their private markets allocation, some may be tempted to pick up certain LP stakes in the secondaries market at this time, but LPs shouldn’t expect to get extreme bargains, Lazaric Calvert adds: “Buyers are getting something slightly cheaper than they would have 12 months ago, but that doesn’t mean they’re getting things on the cheap.

“Generally, there is a lot of talk about discounts in this market, but it’s important to remember that even when LPs are selling at a discount to the most recent quarterly mark, the return they are making on the portfolio overall – since the day they invested – is, in most cases, very healthy. As such, taking a discount may be palatable in order to achieve liquidity.”

Appetite strengthens, but not for every product

Over half (56 percent) of LPs plan to find the cash to commit to private equity secondaries funds over the next 12 months – the largest proportion of respondents to express their interest in the market since 2019’s previous high of 53 percent.

“A secondaries fund really helps to enhance the risk return in your alternatives portfolio, and I think some LPs were seeking that,” Rubin says. “It’s still a growing industry as well. We should not underestimate that.”

“A lot of LPs still need to build teams to be able to cover the [GP-led] market actively on an ongoing basis”

Lea Lazaric Calvert
Evercore

However, one point that is deterring LP interest is a concern that exposures are becoming concentrated in secondaries funds. “It is diminishing, to them, some of the benefits of the risk return as they come back to being more like buyout funds if they become too concentrated, so that can be an issue,” Rubin says.

In that sense, it shouldn’t come as a huge surprise that 61 percent of respondents have no plans to invest in dedicated GP-led secondaries funds.

Although the trend of investors putting money into GP-led secondaries is on the up, it will take longer than 12 months to raise significant capital into this strategy, Lazaric Calvert says: “[It’s] partly because the primary fundraising market, which is currently extremely busy, is taking a lot of the capital away from new strategies, but also because it’s an education process similar to what the co-invest market went through some years ago.

“The GP-led market has exploded onto the scene in the last two to three years and a lot of LPs still need to build teams to be able to cover the market actively on an ongoing basis.”

The balance of where the capital to invest in secondaries comes from is also underway for LPs – whether LPs will have to invest less in co-investment to spend more in secondaries, for example. “That process is going on and we just need a bit more passage of time for that to sort itself out,” adds Lazaric Calvert.