Dispelling the Myth of the Distressed Seller

One of the top ten private equity funds raised last year wasn’t even a private equity fund. At least not in the traditional sense. Coming in at tenth place was Blackstone Group’s $11.1 billion raise for Strategic Partners VIII, the largest secondaries fund ever raised until it lost that distinction to Lexington Partners at the start of 2020.

Demand among investors to commit to secondary funds has never been higher. The reason for this is simple. The rise of secondaries is due, in large part, to the rapid growth of alternatives. As private equity has ballooned, it follows that some LPs would like to unlock liquidity in these closed-ended funds.

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.

Secondary Pricing report H1 2019