Mastering Illiquidity: Risk management for portfolios of limited partnership funds

6

The Secondary Market

Secondary transactions refer to the buying and selling of pre-existing limited partnership interests in private equity and other alternative investment funds. These interests include both commitments that have already been drawn down by the GP and unfunded commitments. Importantly, the transfer of investor commitments between LPs in the secondary market must not be confused with secondary buyouts or similar transactions where a deal is exited by selling the underlying portfolio company to another fund.

The emergence of a secondary market for stakes in limited partnerships has been hailed as the advent of liquidity in an otherwise illiquid asset class. With liquidity risk being reduced, it is generally expected that the broadening and deepening of the secondary market will help fuel the growth of the primary market for investments in private equity and real assets. While long-term allocators who are already exposed to these asset classes may be encouraged to increase their current allocations, a higher degree of liquidity, so the argument goes, could expand the universe of potential investors who would otherwise be constrained by the liability profile of their balance sheets. Furthermore, the growth in secondary transactions has often – and mistakenly – been viewed as a superior means of price discovery compared with subjective NAV estimates of invested capital.

Indeed, the secondary market for fund investments has gained substantial momentum over the last ...