Secondary fund returns cool off: Buyouts analysis

Secondary firms raise funds to buy interests in illiquid limited partnerships from investors who no longer want them. The 2004-2008 vintage secondary funds in our database generated a bottom-quartile IRR of 6.0 percent, median IRR of 10.4 percent, and top-quartile IRR of 16.3 percent. Solid, but still well below the performance of the pre-2004 vintage secondary funds. Those generated a bottom-quartile IRR of 9.8 percent, median IRR of 16.8 percent, and top-quartile IRR of 24.6 percent.

All told for this exercise we looked at 46 secondary funds in the Buyouts returns database whose investors provided IRRs—22 pre-2004 vintage funds, and 24 2004-2008 vintage funds. For more details on our methodology go to p. 48 of the Sept. 2 edition.

We found a similar difference in performance when looking at those secondary funds that provided investment multiples. The 2004-2008 vintage secondary funds generated a bottom-quartile investment multiple of 1.2x, median multiple of 1.3x, and top-quartile multiple of 1.4x; by comparison, the pre-2004 funds generated a bottom-quartile multiple of 1.4x, median multiple of 1.6x, and top-quartile multiple of 1.8x.

Why returns have fallen is a matter of speculation. Among the most likely reasons: the growing number of secondary buyers entering the market with significant war chests with which to bid on LP interests. Such a boost of buying power, lacking an equally large growth in the supply of assets to buy, would tend to drive up prices. Another possible reason has been the changing nature of the market. Sellers of years past often were distressed, willing to accept big discounts to NAV in the interest of speed and discretion. Today’s sellers are often looking to do some portfolio pruning. They tend to be more patient, less afraid of publicity, and focused on maximizing price.

(Correction: A boost in buying power without a corresponding increase in the supply of secondary assets to buy would tend to drive up prices, not drive down prices as stated in original version of this story.)