Improving Risk/Return Through Private Equity Secondaries ImprovingRisk/ReturnThroughPrivateEquitySecondaries

Private equity has been an attractive asset class in recent decades because of the outperformance against its listed peers and the low-risk parameters when building a diversified portfolio. Many long-term investors, like pension funds, foundations, insurance companies and family offices, have invested a considerable amount of their overall assets into private equity.

Indeed, Montana Capital Partners’ recently published Annual Investor Survey shows that half of all foundations and family offices have an allocation larger than 15% in private equity and more than 20% of all institutional investors do the same. About a third of institutional investors, and 87% of family offices and foundations, reported an allocation of more than 10% of their portfolio to the asset class, a trend that is expected to continue. In the last 12 months, 60% of the investors in our survey have increased their allocation to private equity.

Part of the attraction comes from the early access to technology-driven companies that private equity offers. Venture capital and growth funds have been supporting entrepreneurs since the 1970’s and have had especially good success in the US with investments in some of the largest and well-known technology companies in Silicon Valley.

Meanwhile, private equity secondaries remain one of the top three long-term strategic preferences of investors, ahead of some other well-established strategies. More than half of respondents to our survey dedicate at least 5% of their private equity allocation to secondaries strategies, primarily to mitigate the J-Curve and to improve the liquidity and risk-return profile of their portfolio.

The pandemic’s impact

In the past couple of years, the impact of the COVID-19 pandemic has only served to accelerate the growing trend of technology investment. In a recent article, Private Equity International (PEI) analyzed the private equity market with data from CEPRES that showed that close to 50% of private equity deals in 2020 were tech deals. The share of technology-based deals increased significantly in the early-stage as well as in the late-stage and buyout area for PE-related deals, highlighting how the private markets provide capital to firms through their full life cycle.

It’s important to keep in mind that private equity is a long-term investment, and that’s particularly true for VC investments. If an investor invests into a VC or growth fund, their capital will be deployed in relatively young companies which need time to develop their business ideas and grow revenues and profits with the support of private equity fund managers.

To illustrate this point, look closer into the split between the realized and unrealized funds in the chart below. First of all, private equity is a long-term asset class; investors shouldn’t be calling their fund managers in the first few years to ask where their money is! However, a typical buyout fund starts to distribute back to investors after around three years, and pays back well over 50% after 10 years. Slightly behind are growth funds. Average VC funds, on the other hand, take more than five years until their first distribution and still have the majority of their multiples unrealized after 10 years.