4 reasons GP-led secondaries are here to stay
GP-led secondaries emerged from obscurity a decade ago to claim half of today’s private equity secondary market. Most market participants never anticipated the pace of growth, and many still wonder whether GP-led secondaries are a passing fad or a durable market innovation. Right now, the resiliency of the segment is being tested amid public market volatility, interest-rate hikes, and nagging inflation. This leads to an existential question: Were GP-led secondaries a function of a buoyant economy and abnormally low interest rates or do they represent a true private market innovation that will survive the downturn and continue to play a role in the future?
GP-led secondaries are going the distance
We argue that general partner (GP)-led secondaries will continue to be a major component of the private equity market for years to come. We cite four reasons: the lure of customized liquidity, increasing sponsor adoption, a supportive regulatory framework, and—most important—the attractiveness of the risk/return proposition.
1 The lure of customized liquidity for LPs
The drive for liquidity has been a fundamental force shaping the development of the secondary market for decades. The introduction of limited partnerships (LPs) to access private markets exposure didn’t include an easily accessible liquidity mechanism for LPs. Once invested in a limited partnership, typically the LP received liquidity through sponsor-created distributions. The secondary market introduced a liquidity mechanism that didn’t depend on sponsor action; however, a partnership sale was a blunt-edged instrument—it was an all-or-nothing choice. In selling a fund interest, an LP was forced to divest exposure to all portfolio companies regardless of a preference for some companies and not others.
GP-led secondaries have refined the secondary market’s basic tool kit. The transaction enables a surgically precise way to shape private equity exposure at the asset level. This innovation has been embraced by market participants and is now considered by sponsors to be an additional exit option. As with any innovation, there’s been resistance to the complexity of this new mechanism; however, the rapid growth of GP-led secondaries demonstrates that there was pent-up demand for customized liquidity, a demand that we believe will survive through bull and bear markets alike.
2 Increasing sponsor adoption
While the private equity market has been growing for decades, the structure of the industry has remained largely unchanged. Sponsors raise commingled funds, invest in portfolio companies, improve company performance, and monetize assets through sales or initial public offerings. When liquidity is returned to investors, sponsors seek to recycle it into follow-on funds. There’s a wash, rinse, repeat cycle to this rhythm.
By the mid-2010s, the secondary market had become large enough to force changes on the decades-old private equity rhythm. Early GP-led secondary transactions—often called fund restructurings or fund recapitalizations—raised awareness, as certain sponsors started to see secondaries as part of the capital markets. Over time, more sponsors began to engage with secondary investors in new and novel ways. This form of innovative and dynamic engagement, and one-off deal-making, morphed into today’s robust GP-led secondaries market. The result has been a burst of additional options and flexibility for all market participants, not only in terms of liquidity but also in terms of performance realization, incentive realignment, ownership structuring, and asset-gathering strategies.
The fact that an entire cohort of bankers, lawyers, valuation agents, and other service providers now specializes in GP-led secondaries only reinforces the permanence of the structural change wrought on the private equity market. Clearly, this group of specialists has a vested interest in keeping the market operating through ups and downs.
GP-led secondary transactions now represent nearly half of the market
Secondary market transaction volume over time (billions USD)
Source: Evercore, 2023. GP refers to general partner. LP refers to limited partner.
3 Regulatory framework
The private markets have come under increasing scrutiny as more capital has flowed into private partnerships. The regulatory framework for public securities is clearly defined, but the regulatory infrastructure for private assets is still evolving. As an example, the SEC recently reviewed practices specific to fund-raising and sponsor-initiated transactions. The guidelines seem to focus on ensuring market participants are treated fairly and that conflicts are appropriately disclosed. While a small number of entities have in the past (or likely will be in the future) been flagged for insufficient disclosure or other questionable actions, there’s no evidence that regulators wish to prevent innovation or curb a functioning secondary market. In fact, these guidelines provide a framework for a fairer market, which often foreshadows healthier and larger transaction volumes over time.
Vigilance by sponsors, advisors, secondary investors, and other industry participants is critical to ensuring that innovation and growth aren’t harmed by bad practices or bad actors. However, it’s unlikely that the market for GP-led secondaries bears more regulatory risk than other parts of the private equity market.
4 Attractiveness of risk/return proposition
For years, asset allocators gained private equity exposure primarily through commingled funds. Over time, two innovations emerged that were added to the allocator’s tool kit: Co-investments enabled concentration to be part of portfolio construction and traditional LP secondaries introduced shorter duration as an attractive attribute. Both options were welcomed, but each had limitations. Co-investments are typically offered at the time a sponsor purchases a new platform company. This lack of history introduces risk as the sponsor, management team, and company are coming together for the first time. Traditional LP secondaries shorten the J-curve, but the return on these investments is typically bounded by the age and past distribution activity of the partnership.
GP-led secondaries have improved on the value proposition of co-investments and LP secondaries, effectively creating a sweet spot for private equity allocators. Companies in GP-led secondaries are known to sponsors, as they’ve previously owned and typically added value to them. Instead of selling, they’ve decided to retain the company to capture additional performance. Overall risk is lower through continuity, while appreciation potential remains high. GP-led secondaries typically model multiples on invested capital of at least 2.0x and internal rates of return of at least 20%, and project a three- to five-year holding period. This combination of potentially higher return for lower risk and shorter duration compares favorably with co-investments and traditional LP secondaries. As allocators come to appreciate this unique value proposition, we believe demand for GP-led secondaries will continue to grow, bringing more capital into the market and reinforcing their reason to exist.
GP-led secondaries sharpen the investor's tool kit
For decades, the secondary market delivered fund-level liquidity through LP secondaries. This served as an important release valve for the private equity market; however, fund-level liquidity could only be used to shape private equity portfolios broadly and was a blunt-edged instrument. The introduction of GP-led secondaries vastly improved the asset allocator’s tool kit, offering customized liquidity for concentrated positions within funds, and has become much more akin to a surgeon’s scalpel.
From an investment perspective, LP secondaries can offer an attractive value proposition: discounted purchase price, short-term cash flow, and diversification. At scale, LP secondaries enable the investor to capture the beta of the secondary market, effectively an index of private equity. GP-led secondaries offer a different investment proposition; in essence, they create an opportunity for potentially higher risk-adjusted returns with shorter duration, the alpha of the secondary market. We believe GP-led secondaries allow allocators to capture premium returns without taking excessive risk—a proposition that will become increasingly valued over time.
Note: Much of this material originally appeared in Private Equity International’s “GP-led Secondaries Report” on March 6, 2023.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.
The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.
This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management or its affiliates. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Neither Manulife Investment Management or our affiliates, nor any of our directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.
Manulife Investment Management
Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than a century of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams—along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.
This material has not been reviewed by, is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at manulifeim.com/institutional.
Australia: Manulife Investment Management Timberland and Agriculture (Australasia) Pty Ltd, Manulife Investment Management (Hong Kong) Limited. Brazil: Hancock Asset Management Brasil Ltda. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. Mainland China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area Manulife Investment Management (Ireland) Ltd. which is authorised and regulated by the Central Bank of Ireland Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Investment Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad 200801033087 (834424-U) Philippines: Manulife Investment Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G) South Korea: Manulife Investment Management (Hong Kong) Limited. Switzerland: Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. United Kingdom: Manulife Investment Management (Europe) Ltd. which is authorised and regulated by the Financial Conduct Authority United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Manulife Investment Management Private Markets (US) LLC and Manulife Investment Management Timberland and Agriculture Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited.
Manulife, Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.