With near-constant reports on the growth and scale of the secondaries market, and headlines announcing marquee secondary fund closings, such as Carlyle AlpInvest's recent $20 billion fundraise, one could be excused for wondering how the market could be undercapitalized.
Despite these large fundraises, along with many new entrants in the space and rapid growth of retail secondaries products, secondary opportunities continue to dwarf buy-side capital. This is particularly pronounced in an otherwise more muted exit environment, where M&A and IPO opportunities have been more challenging and both LPs and GPs are finding secondaries present an alternative path for delivering capital back to LPs and a valuable portfolio management tool.
Buy-side capital constraints exist across the market as more and more LPs and GPs consider secondary transactions alongside more traditional realization paths. For example, as secondary funds have grown in size (with minimum deal sizes growing accordingly), a gap has emerged at the lower end of the market where there are only a handful of buyers prepared to lead GP-led transactions below a certain deal size.
As deals get larger, the challenges of corralling buy-side capital increase. Particularly as syndication processes can be more susceptible to broader market trends, GPs are increasingly focused on partnering with secondary buyers of scale who can underwrite all or a significant portion of a sizeable GP-led transaction, helping de-risk the syndication process. Conversely, secondary buyers remain keenly focused on their own portfolio construction, and individual transactions may simply be larger and/or more concentrated than a buyer would like for its fund.
Capital constraints are also playing a role in the LP trade market. As the size of many mega investors' investment programs continues to grow, their periodic rebalancing sales have likewise grown in size and multi-billion dollar sales are now common. Many of these portfolios are sold to multiple buyers in a 'mosaic' to maximize price, but this introduces deal risk for the seller.
Being able to speak for scale and provide a complete solution to a seller of a large portfolio is important in the seller's assessment and selection of a buyer, even in multi-buyer portfolio sales. Related, as buyers evaluate portfolios, they are keenly attuned to the opportunity cost, not only in terms of capital deployed but also in terms of internal resources, which has caused some secondary buyers to shift their focus to larger transactions, again leaving more of a shortfall on the buy-side for smaller opportunities. It is not uncommon for brokers to advise sellers that the market is 'saturated' and to advise a seller to postpone a sale until there are fewer competing opportunities for secondary buyers' attention.
Secondary fundraising continues at a rapid clip, with established secondary buyers raising ever-larger funds, retail products growing in size very rapidly, many new entrants, and a proliferation of sector-specific strategies such as credit or infrastructure secondaries, but that growth has to date been outpaced by the sheer proliferation of deal opportunities for both GP-leds and LP trades. Particularly given the mismatch between capital raised over the past five-to-ten years by alternatives managers and the amount of secondary capital available to deploy, we expect undercapitalization to remain a challenge for the near term.
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