Limited partners (LPs) are showing interest in the increasingly liquid secondary market.

Favorable interest rates, easier access to capital, and growing pressure to deploy capital have led to historical levels of PE deals. In 2013, the U.S. private equity market saw nearly $420 billion in total transaction value. In 2022, that figure surpassed $1 trillion. If you are a private equity investor, you most likely have some new gray hairs to show for that growth in activity.

Not only did the market see a sharp change in the number of deals being closed, it saw considerable fluctuations in the value of deals. In 2020, the median deal value was approximately $40 million. In 2021, this figure skyrocketed to north of $70 million before yoyo-ing back to $50 million in the following year.

The fervent deal activity combined with volatile valuation levels has now put private-market investors in an interesting quandary. Many are finding significant portions of their invested capital tied in primary commitments. Those commitments will now need either aggressive short-term returns (difficult given the macro environment) or longer-hold horizons (rarely preferred) to justify.

These forces together have fueled explosive growth in private equity secondaries, or buying and selling of existing primary commitments.

In 2013, the total volume of secondary transactions amounted to around $26 billion. Less than ten years later in 2022, the market ballooned by nearly 300% to $103 billion in transactions. More interestingly, the volume of general-partner-led secondary transactions grew at a notably higher rate of 860% over the same time horizon while limited-partner-led transactions grew by a relatively moderate 162%.

With market trends putting the return profiles of various asset classes in flux, more limited partners (LPs) are showing interest in the increasingly liquid secondary market.

In keeping with the market trends, general partners (GPs) should ensure they are aligned with LPs in the following areas:

1. What investment horizons are limited partners willing to accept or tolerate? Returning to Earth from elevated valuation levels, the pressure to extract value from investments made at a premium may naturally extend the holding timeline. A serious misalignment on investment timelines could damage LP-GP relationships and disrupt the operations of the portfolio assets. If an LP is seeking an earlier exit than what the GP would deem necessary to meet the return expectations, seeking a new LP who is more tolerant of longer holding periods could ensure better continuity.
2. What are the limited partners’ perceptions toward the strength of returns from their primary commitments? While generating and demonstrating returns are two core features of every general partner, more funds should approach this question around value with the secondary market in mind. As secondaries become more liquid and resistant to trading at significant discounts relative to the net asset value of primary commitments, the transfer of the LP stake is becoming more viable when compared to the “hold-and-see” strategy.
3. What asset classes beyond private equity investments are of most interest to the limited partners? To be clear, we don’t think LPs are rushing to buy the next mint of the Bored Ape Yacht Club NFTs, but several new asset classes are emerging and fluctuating in popularity. As such, routine pulse-checks on the emerging institutional interests of limited partners could gauge their potential appetite to pursuing a secondary transaction for capital reallocation and diversification.

As the debt market remains tepid, the role of limited partners in the private equity sector will inevitably evolve in the coming years, if not months. As a result, a deeper understanding of the secondary market by general partners will become increasingly critical in portfolio management and future fundraising efforts.