Secondary Investors Wait for the Deal Levee to Break

The market for secondhand stakes in private-equity funds reached $57 billion in transactions in the first six months of 2022, a first-half record, The Wall Street Journal reported. But activity dropped off in the second half, as a decline in the value of public stocks led to uncertainty over the valuations of privately held assets and their price on the secondary market.

Market participants are hoping the market will pick up in 2023 as institutional investors, such as public pension programs and endowments, sell portfolios of assets to free capital for new commitments, and as buyout managers, facing a difficult exit market, look for ways to hold on to prize assets.

WSJ Pro Private Equity spoke to several secondary buyers and intermediaries about the market in 2022 and what this year is expected to bring. They include Wilson Warren, partner and president of Lexington Partners; Vladimir Colas, co-head of Ardian U.S.; Todd Miller, managing director in the private capital advisory team at Jefferies Financial Group ; and Christopher Areson, partner in the secondary advisory group at PJT Partners. Responses have been edited for length and clarity.

WSJ Pro: What surprised you about the secondary market in 2022?

Mr. Warren: As 2021 ended, [investors] were forecasting significant liquidity from their private-equity portfolios based on announced and expected exits of underlying portfolio companies. Some deals closed, providing liquidity, but market conditions have curtailed most forecasted exits. The result is that private-equity portfolios are not providing the cash flow expected by [fund investors], creating a growing need for liquidity and increasing secondary deal flow from all corners of the market. The change in outlook has been swift and somewhat surprising.

WSJ Pro: How would you characterize secondary deal flow in 2022?

Mr. Colas: We estimate that over $200 billion of assets were put on the secondary market in 2022 and, of that, final transaction volumes are probably around $110 billion or $120 billion [down from about $130 billion in 2021]. We found buyers more ready to transact than in 2010, for example, where the market froze for a little while. But in this market, you cannot buy everything. Buyers came back and said, ‘We can trade, but we’ll only trade on these 10 funds out of the 30 funds that are for sale.’ We’ve never seen that much cherry-picking in the market.

Mr. Miller: Typically, as it relates to the [limited partner]-led market, the second half of the year is busier than the first [but 2022] has been the opposite. Early in 2022, several multi-billion-dollar [fund] portfolios were brought to market. The second half has been quieter, and it’s really reflective of [valuation] marks and buyers’ perception that many portfolios have not been written down [to a level where they are willing to do a deal]. In some instances, buyers are noting the S&P 500 is trading at roughly 12.5-times trailing 12 months earnings before interest tax depreciation and amortization, while a number of buyout GPs are holding portfolio companies at levels much higher.

WSJ Pro: How do you see the secondary investment opportunity set evolving in 2023 versus 2022?

Mr. Areson: One opportunity is going to be in infrastructure and specifically the power space. The passage of the Inflation Reduction Act is expected to provide incredible tailwinds for the renewable-energy sector. I think there will be legacy projects that require more time and capital and that trend could lend itself to single- and multi-asset general partner-led opportunities.

Mr. Colas: I wouldn’t be surprised if we get close to $200 billion in total volume this year and of that I would expect close to three quarters to be LP portfolios. There is a need for liquidity, there is an overall allocation issue. While I think GP-led deals will stay a very meaningful part of the market and volumes will also increase, I don’t think the GP-led market really solves LPs’ need for liquidity. If you need to make space for $1 billion or $2 billion in your portfolio, opting to sell in GP-leds will take a long time to get you there versus being able to just move a portfolio in one shot.

WSJ Pro: What do you see as the biggest challenge facing the secondary market in the year ahead and why?

Mr. Miller: The secondary funds in the market are massive and, with the help of recycling and some leverage, can do a lot more in deals than the amount they raise. Despite that, our market is undercapitalized. We track the amount of dedicated secondary dry powder available [as a proportion of] secondary transaction volume. That multiple was at 2.5—3.0 times as recently as a couple of years ago. Today, that’s probably down to under 1.5 times. If you look at the top 10 players, they still control the lion’s share of secondary capital in our industry.

Mr. Areson: The valuation gap between where some assets are marked and where those on the buy side want them is a bridge that needs to be crossed. Where that creates opportunity is around structured transactions, such as deferrals, [net asset value] loans and preferred equity. LPs could decide to take proceeds from a NAV loan instead of selling outright, borrowing against a set of assets and taking advantage of a capital arbitrage that might exist between the cost of the debt and the expected appreciation of portfolio value.

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