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The “Yard Sales” of Private Markets

October 25, 2023
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Ben discussed private credit secondaries in an interview at the CAIS Alternative Investment Summit. Watch it here.

Secondaries in private equity funds have long been their own sub-asset class, with billions of dollars primed to purchase stakes in funds that sellers need to offload. Since 2016, The private managers approved by Balentine have taken advantage of this dynamic on the equity side. Today, we are seeing a blossoming opportunity in private credit. With very few dedicated managers and growing assets under management, we believe the time for a private credit secondaries manager at Balentine is here.

What are Secondary Markets?

Most of us are old enough to remember the days before eBay, Craigslist, or Facebook marketplace when the yard sale was the predominant source of buying used goods. Treasure troves of furniture, games, art, and barely-used gym equipment were ripe for the taking if buyers could find the yard sale and arrive early. Buyers who were savvy could spot value, haggle for the right price, and walk away with a much-needed asset, albeit slightly used. While the process was not for everyone, those brave enough to explore the yard sale world were rewarded with sturdy assets at great prices.

Just like yard sales, the NYSE or NASDAQ, are secondary markets for publicly traded stocks. In these spaces, investors buy and sell billions of shares of stocks after their Initial Public Offering (IPO). Whether it’s Apple (AAPL), Nvidia(NVDA), or BlackBerry (BB), investors can purchase shares at a very efficient price. If you ever find something like BlackBerry on sale here, it is likely priced that way for a reason, caveat emptor.

 

Private Capital “Yard Sales”

There is also a secondary market where investors buy and sell existing stakes in private capital funds. There is no electronic exchange for this market and is typically invite-only with prices set by the buyers, not the sellers. Since most private capital funds come with a 10-year lifespan, investors’ allocation to these funds can be set in stone for that timeframe. Starting in the 1980s, however, investors began selling their interest in these funds to other investors who wanted access to them. Typical reasons for selling include the need for liquidity to meet spending, the desire to rebalance the portfolio, or a change in investment leadership with a desire to go in a different direction.

A family hosting a yard sale before a cross-country move is not negotiating from a place of strength; they are more concerned with offloading unneeded items than getting a fair market price for their goods. Just like this family, sellers of private capital interests often give discounts to the buyers. Ultimately, this is a win/win, as the seller gets the liquidity they need, and the buyer gets an asset at a steep discount.

The advantage of buying secondaries goes beyond the discount, however. Buyers receive a fund that is closer to the end of its life, and therefore they quickly regain liquidity. Buyers also have a free look at what they are purchasing. The normal process of private investing is to commit a certain dollar amount to a manager who will make 15 – 20 future investments. At the time of commitment, the investor does not know what those 15 – 20 investments will be. This is called blind pool risk.

 In secondaries, the investor is purchasing a fund that has already deployed capital and has clarity on the 15 – 20 investments they are buying. This removes the guesswork on what they will own and also delivers instant diversification.

 

Opportunities in Credit Secondaries  

A leading indicator for the ripeness of the opportunity in secondaries is how much was raised in the primary markets. The avid yard sale-goer will recall this dynamic, as yard sales were flooded with leg warmers in the late 80s, beanie babies in the late 90s, and P90X DVDs in the late 2000s. We foresee increased opportunity in private credit markets because the assets in the private credit markets have significantly risen over recent years. According to Pantheon, AUM has doubled from 2017 to 2021 and looks to double again (Figure 1).

 

Figure 1. Actual and Forecasted Private Credit AUM

Source:Pantheon

This growth in AUM should provide a more fruitful landscape for credit secondary managers as greater AUM means more investors needing to sell for the reasons listed above. Balentine is currently assessing the credit secondaries space and will look to pair a manager alongside our primary managers.

AUM growth also underlines the need to be selective on the primary credit side. When interest in an asset class grows this quickly, it attracts tourists and fad chasers who try to take advantage of the trend. Balentine will continue to rely on our time-tested due diligence process emphasizing long-tenured teams with multi-cycle track records.

We believe pairing our primary private credit managers with secondary managers equipped to search through the yard sales of the private credit world will deliver a better path and outcome for our investors in the coming cycle.

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