“Secondary-Lite” The Only Secondary Getting Done

Secondary deals are basically frozen until year-end numbers come out, which buyers hope will be bad enough to convince sellers of the deep discounts we’ve been hearing about. While traditional secondary buyers lay in wait, another kind of buyer is stepping in: fund-of-funds managers.

I’m told they’re buying what secondary firms refer to as “secondary-lite.” Meaning, they’re buying earlier stage LP interests. (It’s like the difference between a pre-owned car and a used one.) Traditional secondary buyers prefer to buy funds that are at least 50% invested to avoid the J-curve. But fund-of-fund investors are now seeing discounted interests in funds they may have wanted a piece of as primary investors, and they’re taking advantage. Since it’s earlier stage, they’re still investing, mostly, in the track record of the fund’s managers, the strategy, and the “possibility,” rather than what secondary funds do, which is invest based on the performance of the fund’s existing portfolio.

It works because funds-of-funds have a lower return threshold than secondary funds, which traditionally seek an IRR of around 25%. Since fund-of-funds invest at the start of a fund and endure the J-curve period, their target IRR is closer to 15%. That makes a difference on pricing—fund-of-funds can pay a bit more than the secondary buyers, so the current, pre-year-end numbers prices are affordable.

That doesn’t mean many big secondary deals are getting done, though. The large state pension funds are, for the most part holding back, while the most motivated sellers remain the family offices which were heavily exposed to alternative investments, including hedge funds and real estate. As year-end numbers come out and investment boards of pension funds and endowments see the write-downs, that could quickly change.

I haven’t yet found any fund-of-funds that are willing to admit they’re doing secondary-lite deals on the record, but feel free to pass along your evidence here