Could Harvard & Yale’s endowment sales be a “buying opportunity” for investors?

Ivy League universities Harvard and Yale haven’t been far from the headlines recently.  

The two US endowments plan to sell part of their Private Equity portfolios – $1 billion and $6 billion respectively – to ‘Secondary’ investors. A number of big pension funds and sovereign wealth funds are also selling Private Equity stakes, often at a discount to their underlying net asset value (NAV).

While motives for selling vary, the trend could underscore a potentially significant opportunity, if the underlying assets continue to perform. The current climate may be one of the most favourable moments in recent history to invest in Secondary Private Equity funds (or ‘Secondaries’).

But what exactly are Secondaries? How are they different to regular Private Equity funds? And why might an experienced investor consider this strategy?

To explain, let’s go back to the situation facing Harvard and Yale.

All of this is fuelling an already sizeable opportunity for ‘Secondary’ investors.

In contrast to a ‘primary’ deal – where a Private Equity fund buys a stake in a non-listed company from its original owners – a Secondary transaction typically involves a Private Equity fund or investor selling their stake to another fund or investor.

Secondary funds acquire Private Equity stakes ‘second-hand’ from other managers (General Partners, or GPs) and their end investors (Limited Partners, or LPs). In exchange for providing liquidity, they can usually pick up these assets at a discount.

It’s a small but fast-growing niche. Secondary transactions have soared from $10-20 billion in 2010 to over $160 billion a year. And the scope for further growth could be significant.

Leading Secondary funds are now looking beyond their institutional client base to individual investors. Newer ‘evergreen’ Secondary funds don’t require locking up £millions for decades. In fact, via Wealth Club eligible individuals can invest in these funds from £26,000 – with quarterly opportunities for entry and exit, subject to some restrictions.

So why might an individual investor consider Private Equity Secondaries?

First, this appears to be a buyer’s market with potential for bargains. Demand for liquidity, from GPs and LPs, exceeds supply by a large amount – and this imbalance may well widen.

Leading industry figures have described this as “generational buying opportunity” for investors. Secondary funds could in theory take their pick of the best assets on sale, buying stakes in top Private Equity funds at potentially attractive valuations. These assets are usually marked up to full NAV after acquisition, not guaranteed.

In practice, only time will tell. Ultimately, investor returns will depend on how these assets perform over time, which is not guaranteed. If the assets don't perform, investors will lose their capital. 

There are other possible benefits for investors.

Private Equity Secondaries may be an easy way to achieve diversification. One fund could give instant exposure to 5,000-10,000 underlying companies, helping spread out risk. Secondary funds also provide access to a range of managers, sectors, strategies and vintages – all via a single investment.

Another advantage is that Secondaries bypass the initial stage (0-5 years) of the Private Equity cycle, where risks can be especially high. By investing further along, Secondary funds acquire mature assets that may be closer to exit – potentially offering investors scope for faster returns with a tighter band of potential outcomes than primary Private Equity funds.

There are risks, too. The underlying investments are illiquid and require a long-term investment horizon. Their value could fall, so you could get back less than you invest.

Ultimately, it’s up to the individual investor.

Secondary funds hold a diverse and mature mix of assets, and could be a way for more experienced investors to ‘dip a toe’ into Private Equity. Your upside might be a little lower than in a primary fund – but there’s also less chance of significant losses, although these can still happen.

Over the past 20 years, average annualised returns on Secondary funds were 11.6% per year. This is slightly below primary Private Equity (12.9%), but still stronger than Private Credit (9.5%). If you’d invested $10,000 in a hypothetical basket of Secondaries in early 2005, your stake might be worth about $89,000 today. By comparison, you would have $114,000 or so from an equivalent investment in primary Private Equity or $56,000 from Private Credit (see chart). Past performance is not a guide to the future.