The Evolution of Private Equity Secondaries: From Zero to Multi-Billion Dollar Market

These days, most investors are aware of funds (or firms) like Blackstone, KKR, and others that invest in private equity or private debt. However, very few are likely to be knowledgeable about a private market that only started about 40 years ago, yet arguably performed better than all of the others – the secondaries market in private equity funds.

This article looks at the intricacies of this multi-billion-dollar asset class, its evolution and continuing growth, and potential investment opportunities within the secondaries market.

The Growth of Private Markets – When Did It All Start?

The total value of all assets in private markets has reached some USD 13 trillion, having grown especially rapidly over the past ten years.

Worldwide assets in private markets (in USD trillion)
Source: BlackRock

There have been two principal reasons for this record expansion. The first is legal. In 2002, the American government responded to financial scandals involving fraudulent reporting by major companies, including Enron Corporation and Tyco International Ltd., by legislating the Sarbanes-Oxley Act (also known as the SOX Act). The Act was also influenced by the excesses of the dot-com bubble that had burst in 2000.

The SOX Act saddled US-listed companies with extensive and costly new financial and other reporting requirements. The upshot was that many start-ups and other unlisted enterprises chose to delay going public, while several listed companies opted to return to the private sector. For these and other reasons, the number of public US companies fell by more than a quarter between 2000 and 2020.

The number of listed public companies in the US since 2000
Source: McKinsey

The second reason for the growth in private markets was central bank support for the US, UK, and other leading economies when the Great Recession (2008-09) threatened another Great Depression (1929-41). From 2010 onwards, led by the US Federal Reserve, the major central banks pumped a total of more than USD 12 trillion into government bonds and other assets in order to depress interest rates. The initiative was called quantitative easing (QE) and was intended to encourage borrowing and spending.

With interest rates thus driven down to zero, or even turning negative as it was for Switzerland from 2014 to September 2022, investors sought alternatives to bank deposits and other unrewarding public assets. The main beneficiary was private markets for equity and debt.

That explosive growth occurred simultaneously with successive geopolitical and economic upheavals. The 2016 election of then-political-outsider Donald Trump as US president, the coronavirus epidemic of 2020, and, finally, the Russian invasion of Ukraine in early 2022 all combined to create a worldwide atmosphere of uncertainty in the public sector. Despite such worries, however, the financial repression by central banks triggered a major equity bull market across the world’s largest financial centers.

Public or Private – Which Witnessed More Growth?

The point of all this exposition and history is that private markets are affected by the trend in listed securities, albeit, at a distance. This happens because becoming listed is the inherent aim in most private-equity investing. So, from 2010, the powerful uptrend seen in listed-equity valuations also persisted for unlisted issues, pushing them strongly upwards as well.

The net growth of a USD 1 hypothetical initial investment in private and public equity on January 1, 2000
Source: Moonshot

Indeed, private equity far outran the public markets. The chart shows the US experience, but it was a little different in Europe. For pension funds and other institutional investors who had greatly increased their allocations to private markets, this was a problem. Their portfolios had become unbalanced as the private portion gained dominance.

Private equity grew to be by far the largest element in their exposure to alternative investments, much bigger than either hedge funds or real estate. The same holds true for Swiss pension funds, whose allocation to alternatives surged since 2012, with private equity holdings increasing 2.42 times while public holdings only decreased.

US and Swiss pension funds’ allocations history (left: 2001-2022 for US; right: 2013-2022 for Swiss)
Source: Equable Institute, Swisscanto

How could they reduce that commitment and restore their portfolios to their predetermined risk parameters? The private equity funds to which they were committed were all closed-end. Investors were usually locked in for ten years, sometimes longer.

Worldwide secondaries deal volume and CAGR
Source: WTW

Today, what started with a handful of secondaries funds, each with some tens of millions in assets, has exploded into a significant market on its own, with annual turnover often exceeding USD 100 billion. It is dominated by multi-billion-dollar vehicles such as Coller Capital (the first), HarbourVest, Lexington Partners, and Blackstone (the biggest).

Private Equity Secondaries – A New Investment Opportunity

In addition to the factors already cited, another change in the rules established secondaries as not just a new market, but a new investment opportunity. You may have noticed, on the above chart, the 2017 jump in secondaries trading volume that followed a downturn over the previous three years. Mainly that was due to the 2015 introduction of a rule by the Financial Accounting Standards Board (FASB). The FASB is an independent, non-profit organization that sets financial and accounting standards for public and private businesses.

The new rule allowed buyers of secondaries, who habitually acquired them at price discounts of up to 15-20% or more, to value them at the full net asset value (NAV) of the originating fund. Immediately on the purchase of a secondary, therefore, funds could mark it up by as much as 25% – equal to returns from the best private equity funds in a full year.

The rule has attracted controversy. Some argue that, if a fund has an NAV of some USD 100 per share, the sale of some of those shares at USD 80 should trigger a proportionate reduction in the value of the fund’s entire equity capital. Those critics, however, miss the essential difference between value and price.

Value is the objective worth of an asset; price is what, subjectively, investors are willing to pay for it. If secondary prices were not at a discount to NAV, investors would not have bought them so enthusiastically. According to Cambridge Associates, an independent and privately held consulting firm on private equity, that enthusiasm made secondaries the best-performing alternative asset class investment of recent years.

Median net IRR since inception for all private equity and private equity secondaries*
Source: FS Investments

* The chart tracks the median figures for internal rates of return (IRRs). The vintage year shown on the bottom axis of the chart denotes the year in which the various funds were established. The returns are estimates; they are not based on actual profits made through sales of positions.

As can be seen from the chart, there has been a significant downturn in the last several years. For any investor looking to buy into a private equity fund, this is a highly welcome development. That’s because, just like public markets, the best time to make money in private equity is when valuations and returns are depressed. 

Private equity vintage returns
Source: Aura Group

The chart above demonstrates the point well. The area part tracks the price-to-earnings ratio (P/E) of the S&P 500 Index. The columns show the returns from funds of different vintages. Those funds that were established in years that coincided with downturns in the index P/E are the ones that have delivered the best results over time.

The recent slight weakening in private equity returns (IRRs) has continued to the present day. Yet, that means this could now be the perfect opportunity, not only to invest in new funds but also to buy secondaries. Their prices have moved to even greater discounts so that it is currently possible to buy a franc of value for 80 cents – or even less in the case of venture capital funds, where risks are higher (but so are the potential returns).

Secondaries pricing (% of NAV)
Source: WTW

Final Thoughts

After all, however, there is still a problem that persists. Most of the mass affluent in Switzerland and the rest of the world are unlikely to have a hotline to the managers of any private equity funds, nor are they likely to be major institutional investors or secondaries funds with millions to invest. Without having the required minimum initial commitment of typically USD 1 million or more, how can you take advantage of this enticing opportunity?

As a Moonshot member, this is not a problem. We offer exclusive access to some of the most promising new private equity funds from managers with proven track records from USD 10’000 one-off. More than this, you also gain access to our equally exclusive secondaries market, where community members can express interest in selling their securities to other investors from the Moonshot Circle through a bulletin board*.

* Please note that liquidity is neither provided nor guaranteed. Should match-making not be successful, investors can revise their offer and start the process from scratch (according to the product’s terms).

Now is the perfect time to learn more about the opportunities and potential returns on offer in this relatively new asset class that very few even know about. It could be offering a once-in-a-generation opportunity for exceptional reward.