High-profile U.S. institutional investors have chosen to tap the private equity secondaries market.Parradee Kietsirikul/iStockPhoto / Getty Images
Private equity has had an incredible run since the global financial crisis, riding low interest rates and consistently outperforming public market indexes over longer time periods.
Institutional investors have benefited from the ride, and allocations to the asset class continue to rise. According to alternative investment data firm Preqin Ltd., private equity assets under management totalled US$5.8-trillion at the end of 2023, as the number of listed public companies shrinks and more companies choose to stay private for longer.
However, the industry is now grappling with headwinds, including higher interest rates and heightened macroeconomic uncertainty. This more challenging environment will test portfolio managers and expose those with strategies that aren’t built to perform through market cycles.
The lifeblood of private equity is distributions – the money paid back to limited partners after an investment has been exited. The real problem facing private equity now is that the distribution flywheel has stopped.
According to Bain and Co.’s Global Private Equity Report 2025, private equity distributions as a percentage of private equity net asset value (NAV) were 11 per cent in 2024, levels last seen in 2008 during the global financial crisis.
Institutional investors have cash flow models that assume distributions at twice that level to fund their new private equity commitments. When you’re expecting 20 to 25 per cent distributions and you only get 11 per cent, that puts you in a real liquidity crunch.
One of the effects of a strong private equity market over recent years is that many institutional investors have become over-allocated to the asset class. And when the distribution flywheel slows down like it has, that becomes a problem.
High-profile U.S. institutional investors have chosen to tap the private equity secondaries market, including Yale and Harvard universities. The Yale endowment, for example, recently used the secondaries market for the first time to sell US$3-billion worth of private equity investments. Is that a worrying sign and a reflection that Yale sees fewer attractive opportunities in private equity?
Institutions trim their private equity portfolios routinely by selling investments they don’t expect to create as much value. If prices for secondary investments are now better for the seller, that might be an opportune time to trim holdings in lower-conviction positions.
Meanwhile, with many investors seeking liquidity in their private equity portfolios, this could also be an opportune time to invest in secondaries, at least for a component of a well-diversified private equity portfolio. Secondaries offer several advantages for investors, not least of which is the ability to buy an existing portfolio of seasoned private equity fund assets at a discount to their NAV.
That can be instantly rewarding for investors, as typically any assets bought at a discount are immediately marked up to their most recently published NAV (a practice that is compliant with U.S. generally accepted accounting principles). For example, if assets are acquired in the secondaries market at 75 per cent of their NAV, the investor generates a 33 per cent return ($25 on $75) on day one.
Some have questioned market valuations and how such one-day windfalls are possible. But the use of third-party valuation agents is now much more prevalent within the private equity industry, and disclosure practices have come a long way.
Still, while private equity secondaries offer potentially attractive investment opportunities, buyers should beware. The truth is that if an investor buys a massively discounted portfolio of private equity assets in the secondaries market, the investor is taking a gamble on the pace of distributions.
An investment decision predicated largely on the size of the discount rather than the quality of the assets being acquired and their potential to generate future distributions may not be the most successful investment strategy over time. Put another way, if you buy a really cheap portfolio of assets in the secondaries market, it is rarely bought cheaply enough.
Even so, the current environment private equity investors are navigating is creating opportunities for great portfolio managers to deliver strong returns. According to David Nowak, president of Brookfield Corp.’s private equity group, “To say that the whole asset class is tainted is simply not reality.”
In times of uncertainty and nervousness, like now, when many investors are pulling back, some of the most profitable investments can be made. The key is identifying those seasoned portfolio managers who have the expertise and resources to drive operational efficiencies in a company to make it better. Now is not the time to give up on private equity.
Sean O’Hara is co-founder and chief investment officer at Obsiido Alternative Investments Inc. in Toronto.