Providing Liquidity in an Illiquid MarketProvidingLiquidityinanIlliquidMarket

It seems buyers have their questions about these valuations, as exit activity has slowed substantially. According to a recent Bain study, global buyout-backed exit value declined 37% in the first six months of 2022 compared to the prior year. One important exit channel, IPOs, was essentially shut down, with a 73% decline year-over-year.

In summary, investors’ private equity portfolios continue to be valued around record levels set at the end of 2021, while exit activity, arguably because of that, has considerably slowed down. In addition, other asset classes in their portfolio have seen larger corrections. As a result, private equity allocations have increased substantially for many investors, leading to pressure to reduce their private equity exposure.

Fortunately, a flourishing secondary market has developed in recent decades that offers liquidity to this illiquid asset class and can help investors to release the pressure. Rather than waiting years for distributions from the underlying fund managers, investors can sell their positions within a few months to a secondary buyer. In addition to a straight sale, more customized solutions such as preferred equity, earn-out mechanisms, and deferred purchase price arrangements can be offered.

Providing liquidity to the illiquid private equity market also offers various benefits to secondary buyers and their investors. High diversification and J-Curve mitigation have always been key attractions for them. However, in times of high demand for liquidity, such as 2022 and likely the years to come, secondaries offer access to high-quality funds at attractive entry prices.

It is therefore not surprising that the strategy is sought after with investors in mcp’s survey considering it the second-most attractive strategy, just after mid-market buyout, which always takes the top spot. As one investor put it: “We are increasingly thinking about a first-time allocation to secondaries, as pricing is becoming very attractive, and secondaries have historically had strong performance after a downturn.”

These favorable dynamics are further enhanced by the fact that the capital overhang multiple, i.e. the ratio of dedicated available capital to last-12-month (LTM) transaction volume, has come down substantially over the last years. As private equity saw record fundraising and deployment numbers the last couple of years, it is obvious that many of these assets will end up on the secondary market sooner or later.

In summary, a high demand for liquidity for a large amount of private equity assets, coupled with limited capital on the buy-side, represents in our opinion a compelling opportunity for investors.