4 reasons GP-led secondaries are here to stay

GP-led secondaries emerged from obscurity a decade ago to claim half of today’s private equity secondary market. Most market participants never anticipated the pace of growth, and many still wonder whether GP-led secondaries are a passing fad or a durable market innovation. Right now, the resiliency of the segment is being tested amid public market volatility, interest-rate hikes, and nagging inflation. This leads to an existential question: Were GP-led secondaries a function of a buoyant economy and abnormally low interest rates or do they represent a true private market innovation that will survive the downturn and continue to play a role in the future?

GP-led secondaries are going the distance

We argue that general partner (GP)-led secondaries will continue to be a major component of the private equity market for years to come. We cite four reasons: the lure of customized liquidity, increasing sponsor adoption, a supportive regulatory framework, and—most important—the attractiveness of the risk/return proposition.

1 The lure of customized liquidity for LPs

The drive for liquidity has been a fundamental force shaping the development of the secondary market for decades. The introduction of limited partnerships (LPs) to access private markets exposure didn’t include an easily accessible liquidity mechanism for LPs. Once invested in a limited partnership, typically the LP received liquidity through sponsor-created distributions. The secondary market introduced a liquidity mechanism that didn’t depend on sponsor action; however, a partnership sale was a blunt-edged instrument—it was an all-or-nothing choice. In selling a fund interest, an LP was forced to divest exposure to all portfolio companies regardless of a preference for some companies and not others. 

GP-led secondaries have refined the secondary market’s basic tool kit. The transaction enables a surgically precise way to shape private equity exposure at the asset level. This innovation has been embraced by market participants and is now considered by sponsors to be an additional exit option. As with any innovation, there’s been resistance to the complexity of this new mechanism; however, the rapid growth of GP-led secondaries demonstrates that there was pent-up demand for customized liquidity, a demand that we believe will survive through bull and bear markets alike.

2 Increasing sponsor adoption

While the private equity market has been growing for decades, the structure of the industry has remained largely unchanged. Sponsors raise commingled funds, invest in portfolio companies, improve company performance, and monetize assets through sales or initial public offerings. When liquidity is returned to investors, sponsors seek to recycle it into follow-on funds. There’s a wash, rinse, repeat cycle to this rhythm.

By the mid-2010s, the secondary market had become large enough to force changes on the decades-old private equity rhythm. Early GP-led secondary transactions—often called fund restructurings or fund recapitalizations—raised awareness, as certain sponsors started to see secondaries as part of the capital markets. Over time, more sponsors began to engage with secondary investors in new and novel ways. This form of innovative and dynamic engagement, and one-off deal-making, morphed into today’s robust GP-led secondaries market. The result has been a burst of additional options and flexibility for all market participants, not only in terms of liquidity but also in terms of performance realization, incentive realignment, ownership structuring, and asset-gathering strategies.

The fact that an entire cohort of bankers, lawyers, valuation agents, and other service providers now specializes in GP-led secondaries only reinforces the permanence of the structural change wrought on the private equity market. Clearly, this group of specialists has a vested interest in keeping the market operating through ups and downs.

GP-led secondary transactions now represent nearly half of the market

Secondary market transaction volume over time (billions USD)

GP-led secondary transactions now represent nearly half of the market. This chart shows secondary market transaction volume over time: In 2020, for the first time ever, GP-led transactions accounted for more than half the secondary market, and they've remained at roughly half since then.

Source: Evercore, 2023. GP refers to general partner. LP refers to limited partner.

3 Regulatory framework

The private markets have come under increasing scrutiny as more capital has flowed into private partnerships. The regulatory framework for public securities is clearly defined, but the regulatory infrastructure for private assets is still evolving. As an example, the SEC recently reviewed practices specific to fund-raising and sponsor-initiated transactions. The guidelines seem to focus on ensuring market participants are treated fairly and that conflicts are appropriately disclosed. While a small number of entities have in the past (or likely will be in the future) been flagged for insufficient disclosure or other questionable actions, there’s no evidence that regulators wish to prevent innovation or curb a functioning secondary market. In fact, these guidelines provide a framework for a fairer market, which often foreshadows healthier and larger transaction volumes over time.  

Vigilance by sponsors, advisors, secondary investors, and other industry participants is critical to ensuring that innovation and growth aren’t harmed by bad practices or bad actors. However, it’s unlikely that the market for GP-led secondaries bears more regulatory risk than other parts of the private equity market.

4 Attractiveness of risk/return proposition

For years, asset allocators gained private equity exposure primarily through commingled funds. Over time, two innovations emerged that were added to the allocator’s tool kit: Co-investments enabled concentration to be part of portfolio construction and traditional LP secondaries introduced shorter duration as an attractive attribute. Both options were welcomed, but each had limitations. Co-investments are typically offered at the time a sponsor purchases a new platform company. This lack of history introduces risk as the sponsor, management team, and company are coming together for the first time. Traditional LP secondaries shorten the J-curve, but the return on these investments is typically bounded by the age and past distribution activity of the partnership.      

GP-led secondaries have improved on the value proposition of co-investments and LP secondaries, effectively creating a sweet spot for private equity allocators. Companies in GP-led secondaries are known to sponsors, as they’ve previously owned and typically added value to them. Instead of selling, they’ve decided to retain the company to capture additional performance. Overall risk is lower through continuity, while appreciation potential remains high. GP-led secondaries typically model multiples on invested capital of at least 2.0x and internal rates of return of at least 20%, and project a three- to five-year holding period. This combination of potentially higher return for lower risk and shorter duration compares favorably with co-investments and traditional LP secondaries. As allocators come to appreciate this unique value proposition, we believe demand for GP-led secondaries will continue to grow, bringing more capital into the market and reinforcing their reason to exist.

GP-led secondaries sharpen the investor's tool kit

For decades, the secondary market delivered fund-level liquidity through LP secondaries. This served as an important release valve for the private equity market; however, fund-level liquidity could only be used to shape private equity portfolios broadly and was a blunt-edged instrument. The introduction of GP-led secondaries vastly improved the asset allocator’s tool kit, offering customized liquidity for concentrated positions within funds, and has become much more akin to a surgeon’s scalpel.   

From an investment perspective, LP secondaries can offer an attractive value proposition: discounted purchase price, short-term cash flow, and diversification. At scale, LP secondaries enable the investor to capture the beta of the secondary market, effectively an index of private equity. GP-led secondaries offer a different investment proposition; in essence, they create an opportunity for potentially higher risk-adjusted returns with shorter duration, the alpha of the secondary market. We believe GP-led secondaries allow allocators to capture premium returns without taking excessive risk—a proposition that will become increasingly valued over time.

Note: Much of this material originally appeared in Private Equity International’s “GP-led Secondaries Report” on March 6, 2023.

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Paul Sanabria

Paul Sanabria, 

Global Co-Head of Secondaries, Private Markets

Manulife Investment Management

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Jeff Hammer

Jeff Hammer, 

Global Co-Head of Secondaries, Private Markets

Manulife Investment Management

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