The Importance of Private Equity Secondaries in an Evergreen Private Equity Portfolio

Private equity is at a turning point in the wealth market, with investors and advisors navigating how best to allocate across its sub-strategies. The growing availability of funds, both evergreen and closed-ended/drawdown, has expanded the investment landscape and offers several advantages for portfolio construction. In our view private equity secondaries should be the cornerstone of a core/satellite allocation model.

The private equity landscape

Private equity refers to primary investments in privately held companies, with the aim  of creating long-term value by growing or optimising these businesses. Alongside directly investing in private companies (primary private equity), private equity secondaries has emerged as a distinct asset class. Secondaries involve buying and selling existing private equity fund interests or portfolios of assets, providing liquidity for the original investors and creating new entry points into established funds. Investor adoption of this asset class continues to grow.

Investments merits of private equity and secondaries

Understanding the differences between private equity and secondaries can help investors and their advisors assess their respective roles in portfolio construction.

Private equity strategies vary significantly in performance. This is often linked to managers  focusing on particular industries or regions, thus exposing themselves to specific risk factors. For example, technology-focused managers have recently outperformed, while those with larger exposures to traditional retail have lagged.

Given this dispersion, we believe selecting experienced managers who have navigated multiple market cycles and delivered strong performance is crucial when constructing a private equity portfolio. Secondaries offer a solution by providing broader diversification and historically more consistent returns, with better principal preservation. Historical data indicates there is a greater variability of returns in private equity compared to secondaries. In this context, investors should be cautious about building core private equity exposure with a single manager. Also, they should select experienced managers who have navigated multiple market cycles and delivered strong performance, when constructing a private equity portfolio.

Secondaries offer a way to manage the performance variability risk. By providing diversified exposure across multiple private equity managers, secondaries help reduce manager concentration risk, mitigate downside risk and adjust for performance variability across private equity managers.

Historical data indicates that secondaries have exhibited lower correlation to public markets than private equity, potentially further enhancing portfolio diversification. Looking at two major market events—the global financial crisis (GFC) and post-pandemic market correction—secondaries provided greater downside risk mitigation and shorter recovery periods, compared to both public and private equity.

Why secondaries suit an evergreen structure

Secondaries are particularly well suited for evergreen structures due to their:

• Attractive portfolio diversification: Exposure across managers, vintages, regions and sectors can potentially dampen volatility.
• Reduced blind pool risk: Unlike primary private equity funds, secondaries invest in existing assets with known performance histories.
• Earlier cash flows and enhanced compounding: Acquiring interests in established funds leads to potentially earlier and more frequent re-investment opportunities which can improve long-term returns.
• Liquidity management: Broader access to the private equity market enables potentially larger opportunity set for ongoing capital deployment.

Building a resilient private equity allocation

Allocating to a single evergreen vehicle can reduce operational complexity when constructing a private equity portfolio. However, relying on a single private equity manager may not be optimal for investors seeking a best-in-class evergreen allocation. This approach concentrates risk with one manager and potentially limits exposure to a narrower subset of private equity strategies. While investing across multiple primary strategies can enhance diversification, it also increases operational burden and may still leave gaps in portfolio construction.

Most evergreen private equity funds aim to provide broad exposure across a manager’s platform, spanning multiple geographies and sectors. However, private equity managers exhibit inconsistent performance across different periods and segments of the market. Diversified secondaries managers, in contrast, construct portfolios across sectors, geographies and industries, offering exposure to a wide range of private equity managers. This approach can provide greater diversification, making secondaries a strong foundation for an evergreen private equity allocation. Selecting a secondaries manager with broad coverage is key to ensuring a well-diversified portfolio.

While primary private equity strategies can deliver outperformance, their variability in returns suggests they should only be pursued when advisors have high conviction in a manager’s expertise within a specific market segment. In such cases, closed-ended/ drawdown funds with targeted investment strategies may be a more suitable access point than evergreen structures, which can include legacy assets and potentially a broader investment remit beyond a manager’s core specialties.

Secondaries can provide greater diversification and more consistent returns, with better principal preservation. All these attributes collectively make secondaries a strong foundation for an evergreen private equity allocation.

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Jake Williams is Global Co-Head of Alternatives Wealth Management Product at Franklin Templeton

Arthur Thomson is Global Alternatives Product Strategy Specialist at Franklin Templeton

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The views expressed in this article are those of the author and do not necessarily reflect the views of AlphaWeek or its publisher, The Sortino Group