Secondaries are playing a greater role in PE investing in Europe

Private equity (PE) secondaries are increasingly being harnessed by sellers in Europe as an attractive option for actively managing exposure to PE and its various sub-sectors, according to Cerulli.

For buyers—particularly investors new to PE—secondaries can be a highly efficient way to quickly create diversified exposure to different vintages, strategies, and managers, says research from Cerulli Associates.

One of the clear attractions of the secondary market, notes Justina Deveikyte, associate director, European institutional research at Cerulli, is that a buyer on both sides of the market might commit to a new fund and also purchase a limited partner position via a secondary in an older vintage fund in order to mitigate the J-curve on the primary commitment made.

“If the buyer can acquire the older fund at a reasonable discount to net asset value—typically in the order of 10 per cent to 20 per cent—it may be able to ultimately intensify its returns. Secondaries can also be a good tool to mitigate blind-pool risk with highly unfunded vehicles,” says Deveikyte.

Cerulli analysis of secondaries assets under management (AUM) indicates that PE secondaries accounted for all but USD14 billion of the USD137 billion of European AUM as of June 2019.

Diversification is a strong motivating factor. A buyer might be able to invest only on a primary basis in a specific region, but its secondary platform might be agnostic to region or strategy.

Other groups are looking to move out of fund-of-funds vehicles when there is little to no upside in the portfolio, but the buyer is still paying the double layer of fees. Active portfolio management is the key reason for investors wishing to sell on the secondary market. Over-allocation to certain regions or strategies can be one reason. However, the most common reason for investors managing their portfolios to sell is usually to clean up the portfolio and liquidate earlier vintages in order to make room for new investments.

Large, diversified portfolios are among the most sought-after opportunities. Many of the larger secondary players have recently raised multibillion-dollar funds and the most attractive assets to these players are the USD500 million or more multi-fund portfolios containing sometimes hundreds of underlying portfolio companies.

Cerulli says that improved access to data on underlying portfolios through a combination of market intelligence, private company databases, and a network of general-partner (GP) relationships should make the market more efficient at the top end, where competition for large, diversified portfolios is already fierce. At the smaller end of the market, where information remains opaque, secondary players will still have to rely on “boots on the ground” and their own access to small and mid-market GPs.