What will the next downturn mean for secondaries?

Last year was a record-breaking fundraising year for the secondaries market: 23 vehicles amassed a combined $33.9 billion to deploy across private equity, real estate and infrastructure secondaries deals.

Last week, Private Equity International gathered some of the strategy's top professionals in New York to discuss the evolution of their market for an upcoming feature.

Secondaries professionals from Ardian, Debevoise & Plimpton, Greenhill Cogent, HarbourVest Partners and Partners Group all took part in the roundtable discussion.

The consensus was that the secondaries market has remained on a healthy footing in the past 12 months, and that despite heightened geopolitical uncertainty in several parts of the world- including the two main markets, the US and the UK – it's been business as usual.

To be sure, returns have been squeezed in recent years as the market has matured, which has forced firms to focus less on traditional secondaries deals – the transfer of fund stakes – and to be more creative in the ways they source and structure transactions.

As the end of the current economic cycle and the peak of the market approaches, participants in the roundtable also envisioned what a dislocation would mean for secondaries.

One certain consequence is that volume will initially dramatically slow down until sellers and buyers figure out where valuations eventually settle.

“The challenge with a dislocation is that everybody freezes up,” said one of the participants. “You get this hole in the market for three months where nobody wants to do much of anything. Then people start moving to the market because they're faced with a new reality in their economic assumptions.”

A downturn will not be all bad for the secondaries market, others noted, as it will eventually change the mix of sellers and lower pricing for buyers, which could spur returns to go up again.

“If you have a big correction in the equity market, I think the volume will slow down for six to nine months at least,” added another participant. “But a big dislocation would be a challenge and an opportunity.”

The people around the table agreed that one of the biggest challenges for secondaries sellers in a strong private equity market is that there aren't many reasons for institutional investors such as pension plans to sell. They are already receiving strong distributions from general partners and they often can't reinvest that cash fast enough; selling would only exacerbate this problem.

“There's an expectation that net asset values will continue to go up 3 to 4 percent every quarter, so selling at a discount or even at par doesn't sound like a great proposition for sellers,” another participant in the roundtable said.

But the participant added that “a dislocation will right-size a lot of that”.

Obviously, the big unknowns at this point are when the downturn will hit and how long the freeze will last. Our upcoming feature, set to appear in Private Equity International's May issue, will explore this and more from our discussion, including real asset secondaries, how the use of leverage in secondaries transactions is evolving, the appeal of preferred equity for some players and the risks of investing in emerging markets.