The Rise and Impact of Secondary Funds

Thirty years ago, a revolutionary concept emerged in the private equity industry.? The first ever secondary fund was created by the Venture Capital Fund of America (today VCFA Group). This has drastically changed the landscape of acquisition and management of existing investments. Since then, secondary funds have played a transformative role in providing investors with opportunities for liquidity, diversification and risk management.

What factors have propelled the development and growth of secondary funds?

• Liquidity and Portfolio Management: Private equity investments typically involve long holding periods, often spanning several years. Secondary funds provide investors with a mechanism to sell their existing private equity investments and generate liquidity, enabling them to adapt their portfolios to changing circumstances.
• Diversification and Risk Management: Private equity investments can be concentrated in specific companies or industries, posing risks. Secondary funds allow investors to diversify their portfolios by acquiring a variety of pre-existing private equity investments across different sectors, geographies and risk profiles. This diversification helps mitigate risks and enhances portfolio performance.
• More Layers of Due Diligence: Investors in secondary funds benefit from multiple layers of due diligence. The original private equity firms, initial limited partners and the managers of secondary funds conduct thorough due diligence on the underlying investments. This comprehensive scrutiny provides investors with added protection and confidence when participating in secondary fund opportunities.

There are two major types for secondary funds: LP-led secondaries and GP-led secondaries. LP-led secondaries, which were the initial form of secondary transactions, still typically dominate most of the private equity secondary sector. LP-led secondaries involve limited partners selling their interests to other buyers. Meanwhile, in the early 2010s, a new form emerged - GP-led liquidity solutions. General partners began offering liquidity options to their limited partners by selling fund assets or restructuring the fund, leading to innovative transaction structures and further diversification in the secondary market.

Secondary funds have continued to evolve and expand into new asset classes and areas such as real estate, infrastructure, and credit being bought and sold, reflecting the market’s adaptability to meet evolving investor demands. In 2023, the transaction volume in secondaries market reached US$114 billion, being the second-biggest year on record, amidst the challenging fundraising environment.

In this secondary fund series, we will continue to explore and highlight different aspects of secondary funds.

We hope to see you again.?

To contact the authors of this article, please reach out to:

Anson Chan???????????????????????????? +852 2230 3554????????? [email protected]

Natalie Chow?????????????????????????? +852 2230 3505????????? [email protected]

Scott D. Peterman, CFA????????? +852 2230 3598????????? [email protected]

Sook Young Yeu???????????????????? +852 2230 3591????????? [email protected]

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