Secondaries

Discover the benefits of buying private investments from existing investors

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Strategy Overview

(The following contains excerpts from The Holy Grail of Investing, co-authored by CAZ Investments founder, Christopher Zook)

In a traditional private equity fund, investors will wait five to ten years before the fund is liquidated and their capital is returned. So if an investor wants or needs to liquidate their position early, the only way they can achieve this is by selling their position to another interested investor who would simply take their spot. This is known as a secondary transaction.

In 2022, the public markets took a tumble and nearly everyone felt the pain. Stocks, bonds, and real estate fell in unison, so there were very few places to hide. The biggest institutional investors in the world (endowments, sovereign wealth funds, pension plans, etc.) experienced their worst performance since the Great Recession.  How did these massive institutional investors respond?

They took significant steps to get back into balance. While stocks and bonds both dropped significantly, many of these portfolios’ alternative investments (private equity, private credit, etc.) fared much better. This meant their alternatives now represented a MUCH higher percentage of the portfolios’ intended—and often required— asset allocation target. For portfolio managers, this is less than ideal and requires them to take action.  Enter the secondaries market.

In today’s current landscape, we know that there are hundreds of billions of dollars invested in high-quality private equity, private credit, and private real estate assets, many of which have significantly grown in value in recent years. Now they will have to be sold in a secondary transaction in order to help these institutions rebalance their portfolios.

 

Here is a summary of the core benefits of a secondary transaction: 

A Discount

In a private equity investment, there is an existing quarterly valuation of your investment (sometimes called the net asset value, or “mark” for short). If an investor wants to sell their position, they are often going to have to sell their position at a discount relative to its current value

Shorter Timelines

Since it typically takes five to ten years before investors in a private equity fund get all their money back (including any profits), buying a secondary position can drastically cut down on the time it takes to return your capital.  This is also known as shortening the “J Curve” and one of the primary reasons why investors tend to like secondaries.  

Visibility

When a private equity manager starts a fund, you are betting on their experience and track record. This is often called “blank check” risk. On day 1, you do not yet know what companies they will purchase in the fund, how they will perform, etc. However, by the time you’re buying a secondary, the fund will typically have invested its capital so you can see exactly what investments are owned, how they are performing and whether or not you deem them good opportunities. 

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