As it currently stands, the secondaries market has witnessed an uptick in motivated sellers. LPs are addressing concerns around capital calls by offloading fund stakes in exchange for liquidity. And they're selling to derisk overallocated and concentrated portfolios. The denominator effect comes into play here — to counter declining value in other asset classes, LPs are turning to secondaries to rebalance their portfolio. We expect this trend to continue, meaning a sustained increase in deal flow and higher quality opportunities across the board.
We anticipate private debt secondaries to produce above market returns relative to risk. Compared with investments in "mono" strategies such as direct lending, they have the potential to outperform with better or equal levels of risk. Importantly, private debt secondaries offer regular income, further balancing the risk-return profile.
Regular income shortens duration and impacts the discount. And the "effective discount" makes a difference — there is a latent period between the bid for a deal and its close, and any extra yield generated in that time goes to the buyer, lowering the actual price. During a recession, these mechanisms are amplified as price dislocations expand to account for uncertainty.
Prior to the pandemic, a thesis of maturation for private debt secondaries was widely accepted for private debt secondaries. That hasn't changed — if anything, the timeline has been pushed up. To take advantage, private debt secondary investors need to be flexible, globally coordinated and fully aligned, and have a backbone of credit underwriting experience.
Private debt secondaries are designed to not only outperform in bad times, but also to steady a portfolio in the good. And though the market is pointing up now, other exogenous shocks may jolt investors into a sell-off. This makes the asset class a wise allocation. It's ready for a bumpy road ahead. So, when determining your path to overcoming the market's challenges, weigh the opportunity for private debt secondaries.
Olga Kosters is head of private debt secondaries at Tikehau Capital, based in New York. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.