March 2, 2023
Illiquid No More: Creating Secondary Markets in Alternative Investments
There was a time not too long ago when secondary markets in alternative investments would have been considered an oxymoron. After all, illiquidity was a feature of many alternative investment strategies, not a bug. It served the interests of both alternative asset managers (GPs), who wanted to lock in investment from a handful of big institutions, and large endowments and pension funds (LPs) who sought returns rather than liquidity, which they could easily find elsewhere. In any case, the point was moot as secondary trading of alternatives at any scale was neither technologically feasible nor economical.
Virtually all of that has changed. Evolving GP marketing and distribution strategies, the changing composition and needs of investors, and innovations in technology are converging to create a strong catalyst for the emergence and development of more robust secondary markets across the alternatives market landscape.
As alternative asset managers have increasingly expanded their distribution down market to smaller institutions, family offices, and high net worth individuals, they’ve tapped lucrative new pools of investment for their funds, but also heightened the challenge of redemptions. Many of these newer, smaller investors may be unprepared for the liquidity restrictions on their investment, even if they are aware of the five or ten-year lockup period. Life happens, liquidity needs change, layer in an uncertain economic outlook and the result (as we’ve seen in recent months) is some high-profile non-traded funds having to find new solutions for offering their investors liquidity options given current market conditions. These scenarios create not only negative industry chatter, but also an administrative headache in managing redemptions, and less certainty for the investment team in the cash they’ll have to go to market and pursue investment opportunities.
A reliable and viable secondary market can offer an effective solution for all parties. For LPs needing liquidity, it can provide an escape hatch; for investors looking to get into alternatives, it’s another potential means into asset classes that have long had limited access and often at attractive discounts. For asset managers, it lessens the likelihood of having to gate or manage redemptions. And, critically, advances in technology make it possible to unlock liquidity through dark-pool trading without impacting underlying asset values.
The stars and technology are aligning for the creation of secondary markets and one seismic result is that at least some “illiquid” alternative asset classes are likely to get a whole lot more liquid to the benefit of GP’s, and existing and new LP’s.