It has been all quiet on the secondaries fundraising front so far this year seeing only seven final closes worth a combined $2.4bn, a considerable shortfall on the $30bn raised during the same period last year. Average fund size has also fallen by more than half from $876m in 2018 to $395m, Preqin figures show.
As any private equity market participant will know, however, there’s usually good reason for this kind of pullback. Recently, 2017 and 2018 saw the two the most bountiful secondary fundraising on record, with the $45bn amassed in 2017 being the all-time high watermark. While it may seem, given first-half results, that 2019 will see a decrease in fundraising the reality is that several funds are in the throes of reaching their most ambitious targets to date. Preqin estimates that there are 51 secondaries funds seeking a combined $77 billion, many of which have already reached interim closes.
Indeed, in mid-July, two weeks into the second half of 2019, Blackstone announced that Strategic Partners VIII had closed on $11.1bn, breezing past its $8bn target (albeit the final total does include related managed accounts). This makes Blackstone the manager of the largest secondaries fund ever raised, a title it may lose before the year is even out if Ardian and Lexington both close by the end of December. This could mean that 2019 may set a new record, in spite of a dormant first half.
However, as a barometer of the health of the secondaries market, deal value — rather than the funds raised to make those deals — arguably offers a more direct and immediate metric. And on that front the numbers are unequivocal. Completed transactions grew to $46bn in the first half of 2019, up more than 25% on the same period in 2018.
Stepping back and looking at the period 2013-2018, secondary transaction volume has expanded at a compound annual growth rate (CAGR) of 38% to $75bn last year. An analysis by Palico shows that this is vastly outstripping growth in buyout activity, i.e. the value of deals being made by the PE funds in which investors are increasingly trading in and out. In 2013, $309bn worth of buyouts were registered globally, rising to $472bn last year. This represents a CAGR of 7.3% over the same period. Put another way, PE secondary deal activity is growing more than 5x faster than the buyout market it gives investors exposure to.
This points to a bright future. Based on a run rate of these numbers, and a major economic upset notwithstanding, the annual secondary market could be worth as much as $375bn in the next five years. This is of course predicated on a continued CAGR of 38%, which may be overly optimistic. Yet, even if this rate halves, the market will still more than double in value over the next five years.
Clearly the market cannot grow at such a pace indefinitely, limited as it is by the volume of available assets. Naturally, market activity is directly correlated with the PE primary fundraising market. The more funds raised for buyouts (and start-up financing, credit strategies etc), the more available inventory there is to supply the secondary market, typically with a three to five-year lag for those funds to bed down and start deploying before LPs choose which positions to sell.
To date, then, the secondaries market has been playing catch-up. In theory, its growth will moderate in due course, eventually expanding in approximate lockstep with increases (and decreases) in the primary fundraising market.
If we look at the primary fundraising side, we can see that the 2013-2018 period shows a relatively modest CAGR of 4%. Does this mean that secondary market growth will drop to this rate over the next five years, given the inherent lag between primaries and secondaries?
The discrepancy between the two rates (i.e. CAGR 38% versus CAGR 4%) suggests that this is unlikely. Furthermore, it indicates that the secondaries market is still some way off reaching its full potential. There is still plenty of headroom remaining. The increasing sophistication of the market and the growing number of liquidity options available to LPs will support its outpacing of primary fundraising for the foreseeable future.
The million-dollar question is what maximum (or optimum) proportion of the primary fundraising market can the secondaries market realistically account for — and when will that inflection point be reached? In other words, when will the PE secondaries market reach full maturity and, when it does, how large will it be?