E378: Why LPs Keep Selling Their Highest-Quality Funds

Episode Summary

Executive Summary: The conversation argues that LP secondaries can offer superior risk-adjusted outcomes versus blind-pool buyouts, especially as buyout dispersion widens and DPI remains weak. Ryan explains why buyers can often purchase high-quality assets at discounts for seller-specific reasons, why relationships and information matter more than sourcing, and why the secondary market is still early but growing structurally due to liquidity needs and governance constraints.

Main Topics: Secondaries vs. buyouts: performance and risk (Priority: 5/5): Ryan argues that secondary funds have historically matched or exceeded many buyout outcomes, with far better liquidity and less downside risk from return dispersion. Even lower-quartile secondary funds tend to remain profitable, while buyouts now have a meaningful chance of losing money. Buyout market dispersion and competition (Priority: 5/5): The discussion explains that the buyout landscape has become much more competitive, with many more managers chasing a finite set of deals. This has increased dispersion and made consistent first-quartile selection far harder than in earlier eras. DPI crisis and LP liquidity pressure (Priority: 5/5): A major theme is the collapse in distributions relative to paid-in capital, which is forcing institutional LPs to seek liquidity through secondaries. The lack of cash back is creating denominator-effect issues and allocation pressure for rules-based investors. Why sellers use the secondary market (Priority: 4/5): Sellers are often motivated by portfolio governance, rebalancing, CIO changes, career incentives, or the need to free capital—not necessarily by asset quality. In many cases, they sell strong assets at smaller discounts rather than weaker assets at bigger discounts. Access, information, and relationship advantage (Priority: 5/5): Ryan emphasizes that secondary alpha comes less from sourcing and more from privileged access, information, and being an approved buyer. ICG’s multi-product relationships with GPs create trust and better visibility into the assets being sold. Market structure and return dispersion in secondaries (Priority: 4/5): The secondary market is growing quickly but still has wide dispersion, especially in GP-led transactions and continuation vehicles. New entrants, incentive structures, and shorter track records are contributing to wider spread between managers. Career advice and team quality (Priority: 3/5): The episode closes with advice that who you work for and with matters more than title or pay. Culture, mentorship, and team longevity are presented as key predictors of long-term success in investing careers.

Key Arguments: Average secondary funds can outperform most buyout funds on a liquidity-adjusted basis, while offering lower return dispersion and faster cash realization. Buyout performance is increasingly uneven; unlike earlier decades, some buyout funds now produce sub-1x outcomes, reflecting greater competition and weaker pricing discipline. LPs are under pressure because distributions are too low to maintain target allocations, prompting them to sell in the secondary market. Secondary buyers can purchase high-quality assets at a discount because sellers are often motivated by governance or career incentives rather than portfolio fundamentals. Relationship depth with GPs is a core edge in secondaries because access to portfolio information and buyer approval matters more than pure sourcing. Return dispersion in secondaries is widening, especially in GP-led and continuation vehicle transactions, as more capital and more entrants crowd the market. The market is still early innings: secondary volume is growing quickly, but it remains a small fraction of the primary private equity market. Long-term track record, senior team stability, and organizational culture are among the best indicators of future investment success.

Data Points: AUM at ICG: $127 billion - Referenced when introducing Ryan’s role as co-head of LP Secondaries at ICG. Secondary market share of private equity: ~2% - Ryan said the secondary market is still only about 2% of the primary private equity market. Secondary dry powder coverage: Just over 1 year of market supply - Based on Evercore’s latest report, dry powder in secondaries is enough to absorb a little over one year of supply. Traditional LP distribution model (Swenson model): ~24% DPI expected - Allocator training benchmark for expected distributions from private assets in earlier eras. 2024 DPI: 9% - Current realized distributions relative to paid-in capital were cited as well below historical expectations. 2025 DPI outlook: 9% - 2025 was projected to remain around the same depressed level. Secondary sale discounts: Mid-high 80s to 90s - Typical valuation range for LP secondary sales, depending on asset quality. CIO tenure: 6.1 years - Used to explain incentives and career pressure that can drive asset sales and portfolio marking decisions. Secondary market growth rate: Doubled every couple of years - Described as a fast-growing market whose supply has outpaced available capital. New capital raised on GP side: $110 billion last year - Referenced as the scale of capital flowing into GP-led continuation vehicles. Private market allocation target example: 15% to 18% - Example of how outperformance can push institutional allocations above target and trigger selling. Capital raised in secondary market: Not enough to support market growth - Qualitative point that capital raised has lagged the expanding opportunity set.

Pivotal Quotes: "You're far better off in an average secondary fund than you are in anything but first quartile buyouts." — Ryan: Core thesis comparing secondary performance to buyout performance and emphasizing liquidity and lower dispersion risk. "We think it's in buyouts. So we don't do venture, we don't do growth, we don't do emerging markets." — Ryan: Explains ICG’s focus on buying secondary positions in best-in-class buyout managers rather than broader private markets. "Who you work for and who you work with is arguably more important than what you do." — Ryan: Career advice on choosing firms, mentors, and teams over title or immediate compensation.

Implications: Secondaries appear increasingly attractive as LPs need liquidity and buyout cash returns lag. For investors, the edge comes from access, discipline, and manager selection. For the industry, expect more growth, more dispersion, and continued pressure on buyout fundraising and distributions.