What Are Secondaries?
Secondary investments represent the transfer of a private equity interest from one investor to another. Secondary buyers purchase an investor’s commitment to a fund and effectively become a replacement investor as a limited partner (LP).
The Anatomy of a Secondary Transaction
Primaries vs. Secondaries
A private equity primary fund commitment refers to an LP’s commitment of capital in a fund. This commitment provides the fund with the necessary capital to make investments in various companies.
In a private equity secondary fund commitment, a secondary buyer purchases a commitment to an existing private equity fund from the primary buyer or secondary seller — effectively becoming a replacement investor.
Secondary buyers gain immediate exposure to an existing, mature portfolio which may generate cash flow sooner than primary investments and which may help reduce risk by offering a diversified portfolio across various vintage years, industries, geographies or even general partners (GPs).
| Primary Fund Commitment | Secondary Fund Commitment |
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An Investor's Journey Across the J-Curve
A capital call, also known as a draw-down, is where the GP of a fund calls on LPs to supply a portion of the amount of capital that they committed at the beginning of the investment. The timing and amount are at the GP’s discretion and, once capital has been called, it is considered “paid-in capital.”
A capital distribution is cash (or securities) paid to an investor when the fund managers realize their investments in underlying companies. In the above graph, the capital distributed (starting in year four) shows the amount of cash or securities paid to investors. As the fund continues to perform, capital distributions tend to increase.
Quantifying the Benefits of Secondaries
Portfolio Benefits
For investors looking to optimize their portfolio strategy, secondaries may be attractive for several reasons.
| J-Curve Mitigation | Portfolio/Vintage Diversification | Risk Reduction From Knowledge of Underlying Assets |
| Investments are purchased farther along in their life cycle, with the potential to reduce the negative impact of management fees and accelerating the pace and timing of distributions. | Secondaries may provide investors with the ability to quickly diversify a portfolio by vintage year, investment strategy. industry sector and fund manager. | When evaluating a secondary transaction, the portfolio companies can be carefully analyzed, reducing the "blind pool" risk associated with primary investments. |
Secondary Resilience & Risk-Adjusted Returns
Secondaries have historically generated attractive returns and low volatility versus other private market strategies. They have the ability to benefit from growth while capitalizing on wider discounts in volatile or distressed markets.
Dispersion Returns by Strategy
Vintage Years: 1979-2018, Ordered by Spread of Returns
Capital Is Distributed Earlier
Secondary funds tend to hold more mature investments than traditional private equity funds. Since private equity investments typically exhibit negative returns in the initial years due to management fees and other expenses, secondaries help investors avoid this stage of the private equity life cycle. And, because secondary funds usually come later in the investment cycle, distributions from exits may be sooner than primary funds.
Percentage of LP Capital Distributed
Hamilton Lane Case Study
Life Cycle of a Secondary Fund
The following scenario illustrates a $1M commitment to Hamilton Lane’s 2008 vintage Secondary Fund (HLSF II).
Expected Cash Experience for Investors
- Investors’ capital may be called down periodically during the investment period and should expect to have 80-90% of their commitment invested by years 3-4.
- The value of investors’ capital should grow over time and that value will be sent back to investors in the form of distributions, also known as realizations.
Secondary Market Overview
Secondary Market Evolution
Initially a niche strategy, secondary investments have become mainstream.
2023’s Secondary Market Outlook:
- GPs are exerting more influence in the market.
- The market dynamic provides flexibility for LPs.
- 1H 2023 volume of $43M was down from $57M in 1H 2022, but recent momentum and smaller bid-ask spreads have market participants expecting full-year 2023 volume close to that of 2022 (>$100B).
- Longer-term supply tailwinds are supported by continued LP/GP acceptance of the secondary market as a liquidity tool because:
- There is widespread LP demand for liquidity and flexibility within their portfolios.
- GP’s are looking to create alternative exit paths and additional avenues for investor liquidity.
Transaction Landscape
| LP Deals | GP Deals | |
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| Supply Catalysts |
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| Key Takeaways |
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Secondary Market Volume by Deal Type
The secondary turnover ratio has consistently ranged from 1.0% - 2.0% for more than a decade
Why Do Limited Partners Sell in the Secondary Market?
| Liquidity | Allocation Issues | Portfolio Management |
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*Source: Greenhill Secondary Market Update (January 2020)
Hamilton Lane Case Study
In this case study, you can see how Hamilton Lane manages relationships to execute deals and provide downside cushion through the strategic use of secondaries.
Background
- An LP wanted to sell a mature investment totaling $15.8M. In secondary transactions, pricing is expressed as a percentage of recent net asset value (NAV).
- The LP restricted the offer to secondary investors with strong primary relationships with the GP, which limited competition among buyers.
Transaction
- Hamilton Lane’s GP relationship allowed us to purchase, as the secondary buyer, the fund position from the LP, or secondary seller.
- Secondaries are often purchased at a discount to NAV, in this case 24%. This discount allowed us to buy $13M in NAV at $9.9M.
Hamilton Lane’s Position
- We received an immediate return of $3.1M, which also provided downside cushion.
- Hamilton Lane will fund all future capital calls and receive future distributions.
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