Articles - Secondary markets a primary asset class in investing


Secondary markets have recently taken the spotlight in the ever-evolving landscape of private markets. Although the number of secondary deals has been continually increasing for years, 2023 has seen significant changes that have affected the landscape. A surge in market participants seeking to meet a growing appetite for liquidity and greater asset discounts have led to a shift in the way investors approach this asset class.

 By Sarah Lochlund, Partner and Senior Investment Consultant and Matt Tickle, Partner and Chief Investment Officer at Barnett Waddingham

 Here we delve into the dynamics of secondary markets, shedding light on key insights, challenges, and opportunities for those interested in exploring this space.

 Whether you are a seasoned investor or new to the world of secondary markets, understanding these trends and their implications is key to making informed decisions in today’s ever-changing private market environment.

 The evolution of secondary markets
 Secondary markets have advanced significantly in recent years. In 2022 alone, secondary market volume exceeded £100bn – triple the amount of 2016.

 The asset class, once considered a last resort option for disposing of standard assets, is now being employed as a conventional avenue for capital exit and reallocation, particularly for limited partners (LPs). Furthermore, secondary markets have emerged as a strategic tool for general partners (GPs) seeking to retain control and manage assets through continuation vehicles. This evolution reflects the growing maturity and acceptance of secondary markets as a component of the broader private market landscape.

 An appetite for liquidity
 The appetite for secondary markets has surged as investors find themselves with a greater stake in their private market allocation. This has stemmed from poor performance in public markets relative to performance in private assets, compelling investors to re-evaluate their private market exposure. In response, investors are making strategic decisions, some opting to trim their private market investments to align with stringent allocation boundaries.

 Pension schemes in particular have been actively participating in secondary markets, accounting for approximately 37% of total transactions in the first half of 2023. The de-risking and re-allocation of assets by pension schemes has been notable trend, reflecting a broader shift towards liquidity and risk management.

 Looking ahead, Q4 tends to be a reassessment period for investors and fund managers, where portfolios are reevaluated, and liquidity options are considered. This seasonal evaluation is likely to increase exit transactions as investors position themselves for this year. We will pay close attention once the data is released for Q4.

 A lopsided advantage for buyers
 One of the most striking trends in secondary markets is the increase of discounts. The level of discounts increased across the market in 2022, to levels not seen for many years, and we expect those to have remained wider throughout 2023.

 These discounts represent the most attractive levels in over seven years. Certain sectors, such as venture capital and technology, are experiencing even more substantial discounts due to concerns over the outlook for these sectors and a corresponding lack of buyers. Predicting how long these discounts will stick around for is difficult and recent data hints they may have already started a modest upward trajectory.

 Sellers aiming to unload less desirable assets may encounter the need to include high-quality assets in the transaction to entice potential buyers. The market dynamic tips the scale of negotiation in favour of buyers, granting them substantial leverage in shaping the terms of the deal.

 The battle between demand and supply
 Secondary markets fared reasonably well in an overall difficult fundraising period and as an asset class, has experienced rapid growth.

 We’re seeing market trends that support the demand for the asset class in the future and so believe this growth will be maintained. A proportion of the increase in primary dry powder will funnel into the secondary market, whilst reduced leverage in deals will demand more capital injection from secondary investors. Alongside this, the evolving view of the secondary market and the readiness of investors to utilise it to optimise asset allocation will increase the range of viable investment opportunities.

 Diligence matters
 While the prospect of acquiring assets or funds at discounted prices sounds attractive, prudence is paramount.

 "Investors should exercise due diligence to identify managers with established and effective investment strategies - rushing into deals solely for the sake of securing a bargain can lead to suboptimal outcomes."
 
 The discount to NAV should not be the sole, or even prime factor used for assessing the attractiveness of a deal. We favour focusing on the anticipated returns from an investment - do the returns look attractive relative to the risks assessed from the underlying assets you are buying, and to the liquid options available in the market? Are they additive to an investors’ overall strategic targets?

 In conclusion
 Secondary markets are not only a source of liquidity but are now also a realm where investors can strategically adjust their portfolios and capitalise on attractive discounts.

 As we navigate the dynamic private markets of 2023, secondary markets stand out as a compelling avenue for those seeking to seize an opportunity, and we expect this to continue into 2024. However, investors should exercise caution and conduct thorough due diligence when considering secondary market deals. Whilst discounts may be alluring right now, it’s essential to assess whether an asset or fund aligns with long-term investment strategies rather than merely acquiring assets for what could appear, on the surface at least, a good deal.  

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