Record Secondary Sales of Private Equity Stakes

The market for secondary sales of private equity (PE) stakes is experiencing unprecedented activity this year, as investors seek liquidity amid a cash crunch and a slowdown in dealmaking¹. Pension funds, endowments, and other institutional investors, who have seen limited cash payouts from their unlisted investments, are driving a surge in these once-niche transactions.¹ The secondary market is on pace to break all-time records, with projections reaching up to $150 billion in secondary sales for 2024, surpassing the previous record of $132 billion set in 2021³.

Surge in Secondary Market Activity

Unprecedented Growth

• First Half of 2024: Total closed transaction volume reached $72 billion, already surpassing the $42 billion recorded in the first half of 2023².

• Projected Total for 2024: Expected to top $140 billion to $150 billion, marking a 25% increase from 2023¹ ² ³.

• LP-Led Transactions: Comprised 57% of the total volume during the first half of 2024, a record $41 billion, representing a 64% year-over-year growth².

Drivers of Growth

• Liquidity Pressures: Investors are experiencing net negative cash flows due to limited distributions from private equity funds².

• Aging Assets: Private equity firms are holding onto unsold investments longer, with over $3 trillion in un-exited assets³.

• Attractive Pricing: Buyers are acquiring fund stakes at smaller discounts, with buyout fund stakes priced between 93% and 98% of their reported value³.

• Dry Powder: A significant amount of capital is available for investment, with $190 billion in dry powder in the first half of 2024².

Participants in the Secondary Market

Limited Partners (LPs)

• Active Sellers: Pensions, endowments, and other institutions are leading the surge in secondary sales³.

• First-Time Sellers: 45% of LPs in the first half of 2024 were first-time sellers, up from 39% in 2023².

• Motivation: Seeking liquidity to manage portfolio allocations and meet capital commitments.

General Partners (GPs)

• Continuation Funds: GPs are utilizing continuation vehicles to provide liquidity to LPs while retaining control over prized assets².

• Multi-Asset Continuation Funds: Used by large-cap GPs to generate optional liquidity in a scalable manner².

• Single-Asset Continuation Funds: Employed by mid-cap GPs, making up 55% of the volume in GP-led transactions².

Implications of Accounting Practices

Marking Up Assets

• Accounting Rule Change in 2015: The Financial Accounting Standards Board allowed investors purchasing LP interests at a discount to mark them up to the net asset value (NAV) of the private equity fund¹.

• Impact on Returns: This practice can significantly enhance the internal rate of return (IRR) for secondary funds¹.

• Criticism: Some experts argue that these gains are not reflective of actual market value and rely on accounting gimmicks¹.

Jeffrey Hooke, senior finance lecturer at Johns Hopkins Carey Business School, stated:

"Tens of billions of dollars are flowing into a particular private asset sector that’s relying on accounting gimmicks."¹

Example: Hamilton Lane

• Hamilton Lane Private Assets Fund: A $2 billion fund launched in 2021, with almost half of its assets in secondaries¹.

• Performance: Reported a 17% IRR, partly due to marking up LP interests purchased at hefty discounts¹.

• Markups: Noted significant gains by writing up assets to NAV on the same day of purchase¹.

Market Outlook and Trends

• Improved Buyer Optimism: Strong public market performance and positive signs in private equity exit activity have contributed to rising fund-level pricing².

• Increased Competition: The influx of dry powder and new investment vehicles has intensified competition for large-scale portfolios².

• Specialist Buyers: Firms like Ardian, Hamilton Lane, StepStone Group, and Lexington Partners raised a record $93 billion in 2023, a 160% increase from the previous year³.

• Pricing Trends: Discounts have narrowed, with some stakes being sold at higher prices compared to late 2022 and early 2023³.

Implications for Investors

Opportunities

• Access to High-Quality Assets: Investors can acquire stakes in established private equity funds at attractive prices.

• Enhanced Returns: The potential for immediate markups can enhance reported returns, although actual realized gains depend on future performance.

• Portfolio Management: Secondary sales allow investors to manage liquidity, adjust exposures, and rebalance portfolios.

Risks and Considerations

• Valuation Concerns: The practice of marking up assets to NAV may not reflect true market value, potentially overstating returns¹.

• Due Diligence: Investors should scrutinize the quality of underlying assets and the validity of reported valuations.

• Market Saturation: Increased competition and high levels of dry powder may lead to overpricing and lower future returns.

Regulatory Scrutiny

• SEC Interest: The Securities and Exchange Commission has shown concern over accounting practices in private assets, particularly in GP-led secondaries¹.

• Transparency: Greater transparency and standardized reporting may be required to address valuation and conflict of interest issues.

Conclusion

The secondary market for private equity stakes is experiencing record-breaking growth in 2024, driven by investors seeking liquidity and buyers attracted by attractive pricing and potential returns. While the surge offers significant opportunities, it also raises concerns over valuation practices and the sustainability of returns.

Investors participating in the secondary market should exercise caution, conduct thorough due diligence, and be aware of the potential risks associated with accounting practices that may inflate reported returns. The evolving landscape presents both opportunities and challenges that require careful navigation to achieve desired investment outcomes.

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_{1. Institutional Investor, Over the past decade the growth of the private equity market in secondaries — LP interests in funds sold to other investors — has skyrocketed, 2024.}

_{2. Institutional Investor, Secondaries Are Pacing for a Record Year Thanks to These Investors, BlackRock Says, 2024.}

_{3. Private Equity Wire, Secondary sales of PE stakes to hit record levels, 2024.}

_{The content herein is solely for informational purposes and should not be viewed as investment or any other advice or a current or past recommendation, or an offer to sell or the solicitation to buy securities or adopt any investment strategy. Certain of this material has been generated by an artificial intelligence language model, ChatGPT, which has been prompted to provide topical finance-related articles. The articles herein may not reflect the most current news, events, or developments. While we strive for accuracy, there may be limitations, inaccuracies, or biases present, and The Buyside Journal (including, for the avoidance of doubt, its affiliates) assumes no liability for the content herein and does not guarantee the accuracy, adequacy or completeness of such information (and does not undertake any duty to correct or update such information). Readers are encouraged to independently verify the information herein and consult with professionals for specific advice or information. Predictions, opinions, and other information contained herein are subject to change continually and without notice of any kind and to the extent accurate initially may no longer be true after the date indicated. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Actual results could differ materially from those anticipated in forward-looking statements.}