Many investors are interested in participating in private markets, a broad category of investments that are not publicly traded on regulated securities exchanges.
One option for investing in private markets is through so-called secondaries (or secondary funds). In this piece, Stephen Donahue, Sr. Wealth Advisor and Director, and Austin Litvak, Director of Investment Research, explain what secondaries are, how they work, and their potential benefits and risks.
What are secondaries?
Secondaries are funds that buy limited partnership interests in existing private equity or private credit funds. They differ from primary investment vehicles in that they do not make the initial investments in the underlying companies or assets. Instead, they are a secondary opportunity to participate in the investment, typically after a strategy has been running for several years.
The secondaries market has grown dramatically in recent years and plays an important role in how institutional investors and families offices manage and rebalance their portfolios.
The two types of secondaries
Secondaries come from two sources: general partners (GPs) or limited partners (LPs).
- GP-led refers to situations where the managers (GPs) of primary strategies (those that make direct investments in the equity of individual companies, debt, or real estate) invite additional investors into the fund for a wide range of reasons – for example, they may do so to extend duration of their ownership of high-performing assets or to create liquidity for the original class of investors.
- LP-led situations are where the underlying investors in primary strategies elect to sell part, or all, of their stakes. They may do so for any number of reasons: to rebalance their portfolio, to shift investment strategies, or to raise cash. An example is Yale University, which earlier this year was reported to be selling about $6 billion in private equity investments on the secondaries market.
Source: Jefferies, “Global Secondary Market Review”, Jan. 2025.
What are the potential benefits of secondaries?
Investing in secondaries has several potential benefits, including the following:
- Reduce the J-curve effect: The J-curve describes a performance pattern that commonly occurs with private equity strategies. Initial returns in the early years of a private equity investment can be negative due to management fees, the costs of acquiring companies, and the investment and work necessary to restructure a company and its assets.
Over time, those assets begin to generate positive cash flows. Investing in seasoned secondaries can truncate (or possibly eliminate) the time until investors begin receiving cash flows.
- Discounted entry prices: Secondaries provide liquidity to investors in primary investment vehicles, typically at a discounted price, which can enhance returns if the companies/assets perform well. Investors often extract a premium for providing liquidity. For example, an institution like a university endowment might look to exit a private equity investment as part of an overall rebalancing exercise. In order to sell an illiquid asset earlier than originally planned, it may offer assets at 85 cents on the dollar — in other words, at a 15% discount to the GP’s valuation. Investors in secondaries ultimately seek to realize the full value of those discounts upon exiting the fund at some point in the future.
- Invest in seasoned assets: Since the private investment strategy has been underway for some time at the point the investment is available to secondaries, there is a track record to evaluate. Since the assets are seasoned, secondaries can provide better insight into managers’ ability to create value — whether through working with management teams, improving profitability, growing revenues, acquisitions, and so on.
- Broader diversification: Secondaries invest in the LP interests of other funds. In doing so, they provide investors broader exposure to more vintages, more managers, and more underlying portfolio companies. Some investors like to think of allocations to secondaries as providing a broad “core” exposure to a particular private asset class or asset classes.
- Shorter holding periods: investing in seasoned assets can reduce the time money is locked up in private market vehicles, which can improve capital efficiency.
Potential drawbacks
The potential benefits of investing in secondaries notwithstanding, there are a number of potential drawbacks:
- Valuations may be stale or inflated: Investors may potentially overpay if the valuation they’re being offered on an investment is stale or inflated. It is imperative to be able to run detailed due diligence on the strategies being offered.
- Reduced upside vs. primary strategies: While seasoned companies/assets may avoid the beginning of the J-curve, the flipside of this risk is the possibility of missing out on the period of highest growth that can occur with younger companies/assets.
- Adverse selection: It is important to understand the motivations of the GP or LP for selling specific assets. There is a risk to be mindful of that these assets may be offered to avoid markdowns on poorly performing primary fund assets.
- Complexity compared to public investments: As with any private investment, a higher standard of due diligence is required because the investments are subject to different regulatory, reporting, tax, and legal issues relative to public market investments.
Conclusion
When investors are considering how to invest in private markets, secondaries may be an option to consider. Investors should speak with a wealth advisor to determine the strategy that’s right for them.
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