Energy funds have been notable for their absence in recent years, the commodity crash of 2014 has cast a long shadow. The strong correlation between the value of operating companies and the oil price, which has made a slow and stuttering recovery, has meant LPs have had to wait a long time for limited distributions. Naturally, the demand for new fundraisings in the sector has been lackluster.

The likelihood of a recession in the coming 12 months rather depends on which economist you speak to, and whether their glass is half full or half empty. One question on the minds of PE investors is, assuming there is an economic moment of reckoning on the horizon, what this will mean for their private equity portfolio and asset allocation. Regular readers of Palico's blog will already know that we have discussed the potential for the 'denominator effect' to throw portfolios out of whack, forcing investors to seek liquidity in the secondary market in order to downsize their PE exposure relative to other, more fluctuating asset classes.

Measured against the circa $70bn private equity secondaries market, private debt secondaries are small potatoes. For now, at least. However, good sense suggests that is about to change. So far, 2019 has provided compelling evidence of what could be the coming advent of private debt secondaries.

Unlike picking stocks, private equity investing is something of a black-box exercise. Select a GP, entrust that manager with committed capital and hope that they diligently curate a portfolio of assets that reap rewards over the coming decade. Secondaries, meanwhile, put investors in a far more transactional, hands-on role. This is where it is important for investors to fully understand the dynamics between current reported value and the potential for future upside.

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. 

Secondaries fund managers are in an arms race. For the last few years, Ardian and Lexington Partners have been vying for the top spot, raising successively record-breaking vehicles to snatch up every pre-owned PE fund stake in sight. However, they’re not the only ones amassing hefty arsenals. Nine of the ten largest firms in the market at the beginning of 2019 had raised the targets on their latest flagship funds by an average of 75%, PEI data show, in a case of “go big or go home”.

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GP-led secondaries hit a record $22bn in 2018, a 38% increase on the previous 12 months and triple the levels seen a year earlier. The momentum has continued into 2019 with H1-2019 doubling the figures from H1-2018.

Few talk about the denominator effect these days, but they soon will. For those with short memories, the phenomenon refers to the relative weighting to private equity (the numerator) in an investor’s portfolio growing by virtue of a fall in the public markets (the denominator). This skews target allocations, forcing LPs to rebalance their portfolios by selling fund positions in the secondary market.