New era of innovation offers greater breadth of opportunity with the growth of GP-led continuation vehicles, says Lorna Robertson, Head of Funds.
The market for private equity secondaries funds has well and truly taken off. Last year, transaction volumes hit $114 billion, up from $103 billion in the previous 12 months, according to Evercore, the investment bank.1 This followed a sudden surge in 2021, after a number of global events and resultant market volatility upended or delayed many funds’ exit plans.
As the IPO market slowed and exit activity all but ground to a halt, falling 70% between 2021 and 2023, a new era of innovation has been ushered in, triggering a sharp uptick in fund manager (or General Partner -GP)led secondaries activity, in the form of ‘continuation funds’.2 What was previously fuelled by necessity is now proving to be an attractive opportunity to provide much needed liquidity for fund managers and investors alike.
Why are continuation vehicles on the rise?
For many fund managers (GPs), the solution to their liquidity challenge was to create a continuation vehicle which would acquire, typically from their more mature funds, single (or multiple) assets, identifying those companies with the most growth potential, using capital from both existing fund investors who wish to ‘follow on’ and additionally, new, secondary investors and by doing so, providing those primary investors who wish to exit at this point (or Limited Partners - LPs) with liquidity. Now, creating a continuation fund is something that more and more GPs are choosing to do, as it gives them the flexibility to continue to manage and grow a portfolio of assets that are performing well beyond the end of the fund life, in order to maximise their value and enhance returns. Data from Pitchbook suggest that continuation funds are starting to come of age, with the number of exits doubling in Q1 2024 compared to the same quarter in 2023.3
Why are they attractive for investors?
To make this strategy work, GPs clearly need to identify new sources of capital to replace the existing investors that decide not to participate in the new vehicle, which a proportion – hungry for liquidity – won’t. The good news is that the continuation fund approach has a lot to offer incoming investors, namely:
Quality: GP-led secondaries funds contain the assets the manager want to stay invested in either to further optimise growth or wait for an improved exit environment (or both).
Visibility: With continuation vehicles, investors already know upfront what the portfolio contains: they are not committing their capital blind as is the case with new funds that have yet to invest. Therefore, the decision about whether to participate is better informed.
Track record: Although the new continuation fund will typically have a lead investor who will independently set the price for the underlying assets, the original GP is leading the secondary transaction retains its stake and investors can take comfort in its track record managing these assets to date, and have confidence that the team has what it takes to achieve the target return going forward.
Potential for price discounts: Where sellers are motivated by a need for liquidity (which is often the case, for example if an LP wants to exit quickly), assets can be accessed at a significant discount to net asset value, boosting returns potential.
Attractive returns profile: Research has shown that secondaries funds can deliver superior risk-adjusted returns compared to primary funds. The risk of losses is lower, and most deliver 1-2x net money multiples, while around 11% have historically exceeded the 2x money mark. 4
Maturity: Typically the portfolio of acquired investments are more mature aTand therefore investors in the CV can look to achieve growth rather than at an earlier stage when the impact of set up costs and fees are still being felt.
Accelerated timeframes: Due to the maturity of the portfolio, exit horizons can be significantly shorter compared with investing in a typical private equity buyout fund, and there is the potential to accelerate cash returns to investors early from these more mature assets.
Diversification: Because the risk/return profile and exit horizons are likely to be different to a traditional primary private equity buyout fund, investing in secondaries can act as a complementary diversifier.
It’s with all these benefits in mind that we’ve been offering our clients access to institutional grade, market-leading GP-led secondary fund investment opportunities for some time.
Private equity secondaries is one of the fastest-growing asset classes in private markets and GP-led continuation vehicles are stoking demand. It’s a strategy that makes huge amounts of sense for everyone involved. For the private investor community, the quality of the assets, the track record of the fund manager, the visibility over the fund portfolio, the attractive pricing, the returns potential, the shorter hold periods, the faster cash distributions and the scope for diversification make secondaries a prime target.
As with any investment there are risks involved. These vary depending on the fund strategy but you can read more on risk in general here.
If you’re interested in investing in private equity secondaries and continuation funds, simply register with us here and we’ll be in touch.