If you like secondaries, you'll love this

As we wrote earlier this year, the secondaries market is booming. It has been the only area of private markets raising more capital than last year to date, an increase of 13.5% year-on-year.

One side of course is the abundant supply of opportunities by over-stretched investors seeking liquidity, as well as from GP’s who raise continuation funds to keep hold of their favourite portfolio companies. This is met by enthusiastic buyers, from ever larger secondary funds to LP’s dabbling directly in this market.

What motivates this surge goes beyond the possible discount – which is not always present or compelling enough to motivate purchasers. Secondaries have become a tool to manage cash flows actively within private equity portfolios, offering immediate or accelerated deployment and earlier realisations than primary commitments.

But in a competitive market where discounts and supply are at risk of dwindling, there are more sustainable ways of generating the sought-after J-curve mitigating effects.

Consider specialty finance; not private credit in a traditional sense, where a small portfolio of direct loans suffers from the same delayed portfolio construction and concentrated risk profile as private equity portfolios. Not to mention increased competition for fewer deals currently. Instead, picture a vastly diversified portfolio of small-balance loans, carefully originated by leading lending platforms, using technology to underwrite and originate and curated by experienced investment managers. Being both amortising and short duration allows a dynamic cash flow management that has been accessible until now through highly specialised hedge fund structures with the optionality to reinvest continually.

To address the lack of visibility on realisation, some experienced managers are now starting to offer closedended vehicles, combining the benefit of compounding returns through capital recycling within a fixed number of years (e.g. a two-year investment period), with contractual realisations and fast distributions (typically within 24-48 months but very front-loaded and finite in time). This yields the following cash profile, which will look familiar to seasoned secondary investors:
 

As in traditional broad-ranging secondary fund portfolios, the high level of diversification (tens of thousands of underlying loans) provides powerful risk mitigation. But a key differentiator vs. equity portfolios is the equally fast and more predictable flow of distributions, starting as soon as the agreed investment period ends.

And in this market too, there are currently opportunities for even faster - immediate - deployment through the purchase of secondary positions, at an advantageous discount. This could prove a powerful tool to mitigate the inevitable lag in capital deployment and its dire consequences on returns. As more traditional private equity funds suffer from a general lull in dealflow due to market uncertainty, unavailability of debt and disagreement over valuations, why not put a portion of your uncalled private markets commitments to work for two years to yield 12-15% in the meantime?