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Private Equity

Secondaries funds hit a low point in 2023, but is a rebound afoot?

In Q2 2023, secondaries funds underperformed the overall private capital market. But leveling valuations may have sparked a rebound in the second half of the year.

Secondaries fund performance lagged overall private market fund performance in Q2 2023 for the first time since 2021, amid a plunge in asset valuations and an impasse in fund distributions, according to PitchBook’s latest Global Fund Performance report.

Secondaries funds generated a 0.2% one-year IRR, well below the 10-year IRR of 13.5% and a massive dip from 24.9% in Q2 2022, a year prior, according to the PitchBook report.

The drop is in part a continuation of a sustained dip in secondaries funds’ yearly performance, which peaked in Q3 2021 at 50.3%—a result of huge NAV markups and favorable returns on secondary sales due to IRR calculations.

The historical fund performance is indicative of an arctic deal-making landscape. In 2022 and 2023, the lofty valuations of the post-pandemic peak fell dramatically, staunching deal flow. In fact, 2022 marked the weakest year in M&A deal activity in the past decade, and 2023 was the second-worst, according to PitchBook’s 2023 Annual Global M&A report.

Secondaries funds also felt the decline in valuations. In Q1 and Q3 2022, specifically, secondaries funds’ quarterly returns fell well below the line for the median NAV, meaning that the vehicles’ unrealized investments had undergone major mark-downs.

With clients opting to hold onto assets instead of selling them on the secondary market at lower multiples, secondaries funds have distributed a lot less capital to LPs since Q2 2022 , compared to historical distributions.

This is also a major contributor to poor fund performance over the period.

A point in time

Suppressed by lower valuations in 2022 and earlier this year, PitchBook analysts anticipated that GPs would hold onto their assets for longer, waiting out unfavorable pricing by extending their exit timelines.

Still, managers have an obligation to generate periodic distributions for their LPs and turned to alternative liquidity solutions, namely secondaries, as a result.

The funds that allow GPs or LPs to sell or purchase portfolio assets have been a popular driver of liquidity in a challenging exit environment. The decline in US PE exit activity, for example, started in Q1 2022 and had fallen 75% by Q2 2023, well below pre-Covid-19 levels, according to PitchBook data.

In 2022, the global secondary market generated $108 billion in total deal volume, the second largest year on record after 2021’s $132 billion, according to Jefferies. GP-led transactions, which allow managers to hold onto trophy assets often through continuation vehicles, absorbed 48% of the total market volume as fund managers waited to sell their most promising investments in a more favorable pricing environment.

Despite the underperformance of secondaries funds in early 2023, market players anticipate that the valuation stabilization in 2023 will reinvigorate overall deal flow and fund performance, including in secondaries.

“Through H1 2023, people were still hesitant to transact, unsure of how well the pricing was holding up,” said Juliet Clemens, fund strategies analyst at PitchBook Data. “But I’ve heard that H2 saw a rebound in deals as sellers felt more comfortable.”

Early signs of stabilization began in Q4 2022, when quarterly fund returns fell within the median NAV component, and they continued into 2023.

Scott Conners, president of FlowStone Partners, a GP focused on private equity secondaries, said his firm saw more deals in the second part of 2023 and experienced a frenzied Q1 2024 as PE valuations settled out and the bid-ask spread continued to compress.

“2022 was just a point in time,” Conners said.

This article has been updated with the correct time period when secondaries fund performance lagged overall private market fund performance. It was in Q2 2023.

Featured image by Siro Rodenas Cortes/Getty Images

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