Private secondary bonds are on the rise as investors increasingly seek liquidity options.
Traders, however, say the market remains underfunded, even though secondary buyers are pouring in more money at a faster rate.
Although some heavyweight buyers have snapped up debt secondaries, investors say the market has done its best to absorb the sell-offs of big-ticket LP portfolios, and it has been hard to come by. buyers for some larger transactions led by GPs.
According to secondhand specialist Coller Capital, trade in second-hand equity investments in private debt funds reached $17 billion in 2022, more than 30 times the total volume in 2012. At the current rate, the value of secondhand transactions is expected to reach $50 billion by 2026, the firm estimates.
A liquidity alternative
Last year’s rise in the private debt secondary market was mainly driven by LP-led selling, according to several investors. This was primarily due to the denominator effect, as falling equity prices left LPs overexposed to private debt and other alternative asset classes. As a result, many investors sell their private debt holdings in 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 and more institutional investors are realizing that this is a potential liquidity alternative for them,” said Andrew Carter, head of private credit secondaries at JP’s asset management arm. Morgan.
John Kyles, general counsel at fund-of-funds manager Portfolio Advisors, said sellers have come to market over the past year with portfolios that include direct lending, mezzanine debt and opportunistic credit strategies.
The financial downturn has also spurred the growth of the nascent secondary market led by GPs. As loan repayments have slowed, limiting capital inflows to private debt funds, GPs have set up continuation funds to both generate cash for their LPs and, in turn, secure top-ups. for new funds.
Other GPs continued to sell strips to reduce exposure to certain assets in which they were overweight. Some were simply trying to secure better economic terms with new investors amid a prolonged market downturn.
“Deal flow for our business grew fourfold in 2022 compared to 2017, and we believe deal flow will likely grow 15% to 20% per year over the next four to five years,” said Rakesh Jain, the global head of private credit at Pantheon Group, who also specializes in secondaries.
In addition to a surge in deals, the average deal size has increased significantly, helping to drive up the total amount of capital invested. It’s not uncommon to see portfolio sales worth hundreds of millions of dollars – in some cases, nearly a billion dollars in value; such transactions were rare two or three years ago.
Traders said they expect economic uncertainty and market volatility to continue to drive the need for cash – and therefore secondary private credit activity – through 2023.
Untapped and underserved
Several asset managers are raising capital to capture more private secondary credit. In February 2022, Coller Capital closed a $1.4 billion institutional fund dedicated to this strategy. A few months later, Pantheon closed its second secondary private credit fund at $843 million, well above its initial target. Meanwhile, JP Morgan has hired two executives to expand its secondary private credit business.
However, even with these large buyers pouring capital into the opportunity, the market is still undercapitalized. Coller Capital estimates that the dry powder held by buyers of secondary private debt securities represents only about half of the annual volume of transactions.
The lack of sufficient capital available for secondary transactions has resulted in some disadvantages, including the difficulty of absorbing some large sales of LP portfolios and finding buyers for concentrated transactions led by GPs. In some cases, larger LP sales are executed through club deals involving multiple investors.
“The volume of transactions [in this market] is much larger than the capital that has been raised and as a result buyers can be very picky about what they buy and the price they pay,” Kyles said.
Kyles added that in some cases, LPs trying to sell large portfolios in late 2022 did not end up trading due to a wider bid-ask spread on valuation. The undercapitalization of the market has also prompted buyers to become more selective.
It is even harder to find buyers for large GP-led secondaries, which typically involve a single fund; they are less diversified than LP-led deals, which may involve exposures to multiple strategies.
“There’s a whole side of the market led by GPs, which are defined continuation vehicles for separately managed accounts looking to liquidate,” said Ed Goldstein, chief investment officer for Coller’s credit secondary business. Capital. “This part of the private credit market is still very immature. GP-led transactions are more concentrated and require large pools of capital. We know there will be a need for capital to underwrite these [deals] In the years to come.”
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This article originally appeared on PitchBook News