Private debt secondaries are on the rise as investors increasingly hunt for liquidity options.
Dealmakers say, however, that the market remains undercapitalized, even as secondary buyers pour in more money at a faster pace.
Although some heavyweight buyers have snatched up debt secondaries, investors say the market has been pulling out all the stops to absorb big-ticket LP portfolio sales, and it’s been difficult to find buyers for some larger GP-led transactions.
According to secondaries specialist Coller Capital, the trade in secondhand stakes of private debt funds hit $17 billion in 2022—more than 30 times the total volume in 2012. At the current rate, the value of secondary deals is expected to reach $50 billion by 2026, the firm estimated.
A liquidity alternative
Last year’s rise in the private debt secondaries market was mainly driven by LP-led sales, according to several investors. This was primarily due to the denominator effect, as falling stock prices have left limited partners overexposed to private debt and other alternative asset classes. As a result, many investors are selling their private debt holdings on the secondary market.
The same phenomenon led to a record level of secondary deals in the broader private equity market in the first half of 2022, reaching $57 billion, according to Coller Capital.
“More institutional investors are realizing this is a potential liquidity alternative for them,” said Andrew Carter, the head of private credit secondaries at JP Morgan‘s asset management arm.
John Kyles, a managing adviser at fund-of-funds manager Portfolio Advisors, said that last year sellers came to market with portfolios that included direct lending, mezzanine debt and opportunistic credit strategies.
The financial downturn has also spurred growth in the fledgling GP-led secondaries market. As loan repayments have slowed, limiting capital inflow to private debt funds, GPs have been setting up continuation funds to both generate liquidity for their LPs and in turn secure re-ups for newer funds.
Other GPs have pursued strip sales to reduce the exposure to certain assets in which they were overweighted. Some were simply trying to obtain better economic terms with new investors amid the prolonged market downturn.
“Deal flow for our firm has grown by a multiple of four times in 2022 as compared to 2017, and we think deal flow will probably grow by 15% to 20% per year over the next four or five years,” said Rakesh Jain, the global head of private credit at Pantheon Group, which also specializes in secondaries.
In addition to a spike in transactions, average deal sizes rose substantially, which helped drive up the total amount of capital invested. It is not uncommon to see portfolio sales worth several hundreds of millions of dollars—in some cases nearing $1 billion in value; such transactions were rare two or three years ago.
Dealmakers said they expect that ongoing economic uncertainty and market volatility will continue to drive the need for liquidity—and therefore private credit secondary activity—well into 2023.
Untapped and underserved
Several asset managers are raising capital to capture more private credit secondaries. In February 2022, Coller Capital closed a $1.4 billion institutional fund dedicated to this strategy. A few months later, Pantheon closed its second private credit secondaries fund at $843 million, well above its initial target. Meanwhile, JP Morgan hired two executives to build out its private credit secondaries business.
However, even with these sizable buyers dedicating capital to the opportunity, the market is still undercapitalized. Coller Capital estimates that dry powder held by buyers of private debt secondaries is only about half of the annual deal volume.
The lack of sufficient capital available for secondary trades has led to some drawbacks, including difficulty in absorbing some big-ticket LP portfolio sales and in finding buyers for concentrated GP-led transactions. In some cases, larger LP sales are being executed through club deals involving several investors.
“The volume of transactions [in this market] is much bigger than the capital that has been raised, and, as a result, buyers can be very picky about what they are buying and the price they are paying,” Kyles said.
Kyles added that in some cases, LPs trying to sell large portfolios at the end of 2022 didn’t end up trading due to a wider bid-ask spread on valuation. The undercapitalization of the market has also spurred buyers to become more selective.
It is even more difficult to find buyers for large GP-led secondaries, which typically involve a single fund; they are less diversified than LP-led deals, which can involve exposures to multiple strategies.
“There’s a whole GP-led side of the market, which are continuation vehicles set for separately managed accounts that are looking to liquidate,” said Ed Goldstein, the chief investment officer for Coller Capital’s credit secondaries business. “That part of the market in private credit is still very immature. GP-led transactions are more concentrated and require large pools of capital. We know that there’s going to be a need for capital to underwrite those [deals] in the coming years.”
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