Secondaries are a relatively new part of the private equity arena but provide a vital role in private markets investing. The ability to trade investments between private equity firms creates liquidity in an otherwise highly illiquid market, offering investors diversification, or the option to get their money back more quickly if needed.

Secondaries in private markets portfolios in a nutshell

Secondaries in private markets are trades where a private equity firm, or other alternative investment fund, buys an investment from another private equity firm or alternative investor.

It is also referred to as the secondary market to distinguish it from the primary market where private equity firms buy investments from a company's original owners. As part of the secondaries sale, the buyer agrees to take on ownership of the investment they are purchasing – for example a stake in a company – and also takes on any outstanding commitments the initial investor agreed to, such as funding.

The secondary market offers private equity investors useful liquidity – the ability to quickly buy and sell – in what is an otherwise illiquid investment arena.

Buyers may make secondaries purchases to take on investments well into their life cycle holding period that can be exited earlier than investments bought on the primary market. Alternatively, the buyer may use the secondary market to purchase an investment more cheaply.

Sellers sell on the secondary market to raise capital, to avoid funding the investment any further, for regulatory reasons, and to rebalance their portfolio by reducing their exposure to a certain asset class or sector. The market for private equity fund secondaries differs from a secondaries fund, where a manager builds a portfolio purely of private equity secondaries.

Types of secondaries explained

Private equity secondaries transactions can be carried out by either a private equity firm’s general partner (GP) or a limited partner (LP), each taking different forms. When the transaction is initiated by a general partner they will sell part or all of the asset or portfolio companies to another private equity investment fund.

In this case, limited partners – institutional investors like pension funds and insurance companies – who hold investments in the portfolio can cash out their interest to a secondary buyer or maintain their positions with the new fund vehicle.

Often secondaries transactions led by general partners use what is known as a continuation vehicle or continuation fund. This allows the GP to roll an asset or assets from one or more existing funds into a new investment vehicle with fresh capital – within the same private equity firm – instead of selling to an outside buyer.

A continuation vehicle allows the investment period of a fund to be lengthened. Some limited partners may decide to keep their investment for this longer period, while others can choose to sell out.

Single asset transactions are a type of general partner-led secondary. This is where the GP cherry-picks certain assets from their portfolio that they want to keep while getting rid of those they believe are out of line with their investment strategy.

By comparison, a secondary led by a limited partner – the institutional investor – is where the LP sells its stake in a private equity fund to another private equity buyer, including all the related assets and liabilities. The secondary buyer then takes the place of the limited partner. Limited partner-initiated secondary transactions are generally more common.

What are the benefits of secondaries for investors?

There are several benefits to investors of secondary private equity transactions.

Access to liquidity

Secondaries provide vital access to liquidity for sellers. Primary private equity investments are illiquid – subject to long lock-up periods and difficult to sell fast. The secondary market, by comparison, allows private equity investors to sell their stakes to unlock cash that can then be invested elsewhere, or used for their immediate cash needs.

Risk mitigation

Risk mitigation via portfolio diversification is another advantage or secondaries. Investors can diversify their portfolios with exposure to a broad range of assets at a variety of different stages of their life cycle, as well as across sectors and geographies.

Secondaries also mitigate what is known as ‘blind pool risk’ – that limited partners invest in a private equity portfolio before it is built (i.e. blind). With secondaries, investors can invest in known companies where there is more transparency about their performance and value.

Higher, faster returns

Investors can buy private equity secondaries at a significant discount, creating the opportunity for superior returns when they come to sell versus the price paid for the investment. This is because when sellers exit private equity funds early – by making their investment available on the secondary market – they have had to sell their assets at a discount, below what their stake is worth, its net asset value (NAV).

So secondary investors can pick up a bargain, with the opportunity to benefit from a higher return when they exit later. This is true except when there is a very high demand for secondaries, then buyers may have to pay a premium to access the investment.

Investing in secondaries – which are by nature part way through their lifecycle (or investment term) – also means investors don’t have to wait as long to see their cash returned. This is known as ‘J curve mitigation’. However, secondary investors looking to benefit from J curve mitigation will have to pay for it with a higher purchase price.

Compliance and regulatory benefits

Secondaries are also in some circumstances useful as a compliance tool.

Banks, for example, when they invest in private equity, now have to keep a certain amount of capital in reserve to cover any losses at risk of arising from such investments. By using the secondary market, banks have been able to sell some of their private equity positions, and, in doing so, meet the amount of capital cover they have to hold to stick within the rules.

How the secondaries market has grown

The secondaries market is experiencing high demand. Fundraising for private equity secondaries hit a record $93.8bn last year, according to data monitor Preqin, an increase of 159 percent from 2022.

In a survey of limited partners taken in April 2024, secondaries topped their list of the most attractive private equity strategies over the next 12 months, Preqin found, with 64 percent of LPs citing it as the best opportunity.

Yet the secondaries market is still a relatively new kid on the block. It grew out of the dot-com crash in the late 90s, when many worried investors were looking for an early exit from their private equity investments.

Now – as an increasingly vital source of liquidity, portfolio diversification, and early exits – market watchers like Preqin expect secondaries strategies' share of the overall market to grow as the broader private equity market matures.