Secondaries face growing investor scrutiny

Private market secondaries investing is attracting more attention and, with it, more scrutiny. Much of that scrutiny has centered on where the returns come from. The most common answer is discounts.

Secondaries transactions are often priced relative to the most recently reported Net Asset Value (NAV) of the underlying investments. If a buyer acquires an interest at 90 per cent of NAV, it is easy to assume that the 10 per cent gap is the engine of returns. This idea is simple and intuitive, but it is also incomplete.

Understanding Secondaries Investing

At its core, private market secondaries mean acquiring existing stakes in private market investments rather than committing capital at the beginning of a fund’s life. Secondary investors step into funds partway through their lifecycle, after assets have already been selected and capital has already been deployed.

These transactions generally fall into two categories. In Limited Partner (LP)-led transactions, an existing investor in a private market fund sells its stake to a secondary buyer. In General Partner (GP)-led transactions, the fund manager initiates a restructuring, typically moving a select group of assets into a new vehicle.

In both formats, the role of the secondary investor is analytical rather than operational. The GP remains responsible for managing the assets. The secondary buyer’s task is to assess the quality of the manager, understand the value of the underlying assets, judge risk and growth potential, and decide what price makes sense.

The Role of Discounts in Secondaries

Discounts explain the entry point, but growth in the underlying assets is what really drives secondaries returns. If an investor buys assets valued at 100 for a price of 90, the apparent value created at entry is 10. But if those assets grow from 100 to 150 over the life of the investment, the total gain is 60. Of that 60, only 10 comes from the initial discount.

The remaining 50 comes from the growth in the underlying assets themselves, reflecting revenue growth, operational improvement, and value creation driven by the GP. The discount may improve the entry point, but it does not replace the need for asset growth.

This is not just a theoretical distinction. In practice, across the secondaries market, the larger share of value creation typically comes from the growth of underlying companies after acquisition, rather than from the entry price alone.

For investors, the appeal of the asset class is clear. Secondaries can provide access to mature assets, shorter time to distributions, and diversified exposure across managers, sectors, and vintages. Those characteristics can create a distinct risk-return profile within a broader private market’s allocation.

However, they do not eliminate the need to understand what is driving performance. Investors must look beyond the headline transaction price and assess the quality of the underlying portfolio.

One key aspect of this is understanding that buying below net asset value (NAV) is not enough. Investors need to understand what they are buying, who is managing it, how diversified the portfolio is, and where future performance is likely to come from.

In the context of secondaries investing, this means that investors should focus on the fundamentals of the underlying assets, rather than just the discount. By doing so, they can make more informed decisions and increase their chances of achieving attractive returns.

Ultimately, secondaries returns are built much the same way as private markets returns more broadly: through the compounding growth of underlying assets over time. The discount may be the easiest part to point to, but it is rarely the part doing most of the work.

Investors can benefit from private credit bubble opportunities in the secondaries market.