Don’t Call it a Comeback – Private Equity Secondaries with Adam Freda of 50 South Capital

Stewart: Welcome to another edition of the Podcast. I’m Stewart Foley, I’ll be your host. Hey, welcome back. Thanks for joining us. Today’s topic is private equity secondaries and we’re joined today by Adam Freda, managing director at 50 South Capital. Adam, thanks for joining us. Thanks for taking the time.

Adam: Absolutely, Stewart. Excited to be here.

Stewart: Okay, so we start this one off like we start them all. What is your hometown, the one you grew up in, what is your high school mascot, and what makes insurance asset management so cool?

Adam: All right. So I grew up in Aurora, Illinois, I think the third largest city in Illinois, with about 200,000 people. So a great place to grow up, still visit there quite frequently. The Marmion Cadets was my high school mascot. It was an all-boys military school, Catholic military school, so a little bit of a unique high school experience. So we were the cadets.

Stewart: Nice. What makes insurance asset management so darn cool?

Adam: Well, I think it’s just the ability to look at all asset classes, stocks, bonds, cash, private equity, real estate. Just it sounds like an exciting variety of things to consider to invest in.

Stewart: Absolutely. And so the secondaries market has been getting a fair amount of attention of late. It’s a very interesting opportunity. And if you would, start us off by giving us a little bit of background on 50 South. Also, how has the secondary market evolved over the last 20 years?

Adam: So, 50 South Capital is the wholly-owned subsidiary of Northern Trust that does private equity and hedge fund investments. So about $14 billion of AUM, $2 billion on the hedge fund to fund side, and then 12 billion of private equity. The core business is a fund to funds platform that does a significant amount of research, meets over a thousand managers per year and builds this great data set and we package up fund to funds as well as custom accounts for our clients, that has spawned a couple other businesses inside of 50 South Capital. We have our secondaries program, which is what I work on. We also have a co-investment fund platform and a credit fund platform. So, we serve both clients of the bank as well as having institutional investors outside of Northern Trust. A 23-year history, a great group of people and it’s been a lot of fun to work here for the last 10 years.

So on the question on the evolution of the secondary market, just because that’s the topic for today’s discussion, it’s really come a long way. This was a market that traded $2 billion of volume in 2002 about 20 years ago. And just for context, the last couple of years were $125 billion and $100 billion. So there’s been explosive growth just in the actual dollars traded. Additionally, probably the first 10 years or so, this was a market that was often sellers that were either stressed, distressed, were trying to get out of unfunded commitments, maybe they were exiting the asset class or had fallen out of… their interest in a particular manager, they had fallen out of interest with. So there was some element of stigma associated with secondaries in the 2000s. The financial crisis changed things in our industry for the positive because there were a lot of banks that had to sell after the regulation following the financial crisis that increased volume into the $10 to $20 billion range.

Those were still sellers that were forced sellers, but it just created more of an ecosystem where buyers were able to deploy capital at scale. Sellers realized that there was more potential liquidity in the secondary market than they had realized. And as the 2010s moved on, we got to about $50 billion of volume in the mid-2010s and again marched up to about $100 billion. I think that CIOs and institutional investors now realized that the secondary market is an excellent tool for portfolio management and portfolio optimization. It’s not really any sign of distress. If you sell a private equity fund, you might be closing out a very successful investment. You might be pivoting from a buyout portfolio to one that includes venture or a US portfolio that now is going to include Europe or Asia.

You can use the secondary market to tweak a portfolio that’s illiquid just like you tweak your stock and bond allocation. So we just think it’s a wonderful tool for asset allocators to be able to move their portfolio around as times change. If you sign up for a private equity fund, you’re often in it for 12 to 15 years. That’s a long time to sign a subscription agreement and throw the key away. Well now there’s pretty reasonable liquidity to be able to get out of these investments for fair prices if you want to tweak your portfolio.

Stewart: You make a very good point. And one of the things that I think… I mean, I’ve been at this for a minute. And I’m not in this secondaries market day to day. But when I think of the secondaries market, my view is antiquated. And when I talk with you, it really helps me to get current because I think one of the things that CIOs face when they start looking at private assets is “How much illiquidity can I take on?” And they don’t want to get too close to the edge, but an active secondary market is a big help. It allows folks to make an allocation today knowing that if circumstances change, I can make a change to that allocation if need be. So when you look at the private equity secondary market, can you talk about how it makes sense from both the buyer’s perspective, which is a little easier for me to see and the seller’s perspective? That’ll be very helpful I think to folks who are looking at both sides of this trade.

Adam: Yeah, absolutely. I mean, I think from the buyer’s perspective, and we’ll probably spend a little bit of time talking about the industry’s returns as well, we do this for our limited partners. This is a form of private equity investing that’s different than buyout investing, venture investing, all other forms of blind pool investing because the investors in secondary funds know that the secondary funds are pricing assets that are already in the fund. We do discounted cashflow analyses and come up with a price that we can pay today to step into the shoes of an investor and we offer the benefit of illiquid private equity investing, but with much shorter duration. If we as a secondary fund are buying a fund that’s five or six or seven years old, we’re naturally going to be closer to the exits of those private portfolio companies. We will generate as an industry, a little bit lower of a multiple of invested capital, but a really nice internal rate of return because the exits happen more quickly.

So we’re able to offer a diversified cashflow stream to our limited partners that has been attractive for the last 20 years. So in that context, why does it make sense for sellers in this market? It’s really just that ability to adjust your portfolio. You can come in and if you’re an insurance company that made a $50 million investment and you’ve already gotten back $90, you’re at a 1.8 times realized, it’s a very successful investment and there’s $20 million left and you’re eight years in, you can sell that $20 for $16 or $17 or $18 million and just be done with it, instead of waiting five to seven years for an uncertain stream of cash flows for the companies that are left in that portfolio. So there’s this baton pass that happens with often the remaining pieces of private equity funds from the original owner to a secondary fund.

We, as an industry, often use some amount of leverage because the cash flows are closer and we’re able to transform lower returns into more attractive returns for our investors with a little bit of leverage usage. That is less common for investors in private equity to use leverage on their own portfolios, but that’s something that the secondary industry can bring to bear. The existing owner has all their historical distributions. Now they have this great lump sum of $16 or $17 million, whatever the case may be, and that capital doesn’t leave the asset class usually. People don’t sell to reallocate to stocks or bonds. They can, but it’s often to just reallocate back into private equity. Particularly right now there’s a lot of stress where investors that have return targets of 15% or 20% of total assets in illiquid investments, those are strict targets and if you’re at 2021, you can’t commit to a 2023 vintage private equity fund.

And from an opportunity cost perspective, that might be a bad vintage to miss. I think a lot of people are pretty bullish about 2023 and 2024. So you have a lot of investors selling old historical investments that don’t have too much left in them to run and reallocating it into 2023 and 2024 commitments that will hopefully be successful vintage years. So it’s really an opportunity to just pivot the portfolio, raise cash without needing to liquidate stocks or bonds to be able to reallocate to private equity and to get back underneath the liquid strategic targets and be able to continue to participate in the asset class.

Stewart: The other thing that I’ve been told is that there’s not a J curve in secondaries. And I throw that term around like I’m somebody who knows what it means. I think I know what it means, but can you just really quickly explain what is a J curve and why is it not there in secondaries?

Adam: So the J curve is a feature of the broad private equity market and it happens for two reasons. One, management fees are charged on committed capital most of the time. So if there’s a billion dollar fund that’s raised and they start investing, the annual fee the first year is $20 million. That just comes right off the top before portfolio companies have grown equity value enough to overcome the cost of that fee that the investors bear. Additionally, private equity funds do their accounting and they usually keep new portfolio companies held at cost for one year and they’ll invest in the businesses for growth. And that growth pays off over time, but it can cause a slight return degradation in the early years on top of the fund’s management fee. And that often causes the returns of buyout and venture funds to be below invested capital or below a one times cost in the early years.

It catches up over time and it’s fine, but there are institutions that have individuals that work there with annual bonus targets and the J curve can be pretty painful in that regard because it’s not until years three or four that you start to see really meaningful performance. Secondary funds have the opposite feature, which is a real benefit. As an industry right now, we’re paying between mid-eighties and low nineties for good buyout funds. But the way that the accounting works in secondary funds is if we pay 90 cents for something, if we buy something for $9 million, we market back to its original cost of $10 million at the time of closing. So there’s an immediate built in gain, which is more than enough to overcome the fees of our funds, and thus the very first capital account statement that an investor would receive from a secondary fund instead of maybe being at 0.98 times cost, might be at 1.05 or 1.1 times cost just because we harvest those discounts that we get on the buy.

Stewart: Thanks. That helps me. And so can you talk a little bit about how the secondary market has performed over time and include in your answer, something about why limited partners invest in this space. I like the things that you’ve talked about. You’ve talked about knowing what the assets are, there’s no J curve. That sounds like you’re going to have solid performance. What’s been the case?

Adam: So Cambridge is the main benchmark that I think we and our peers use, and this is a very interesting asset class. And there’s been a lot of alpha persistence for really the 20 plus year history of the secondary industry. If you take the median of the median returns for the last 20 vintage years, it’s about 14%, net of all fees and carried interests. That in a vacuum is attractive versus stocks. There’s significant public market equivalent outperformance of the median secondary fund versus stocks over essentially all time periods. If you dig a little deeper and look at the quartiles, that’s fairly interesting also because the bottom quartile is often 7% or 8% or 9% positive. That is not an excellent return, but it’s not bad either if you think about what an equivalent stock investment might do. Additionally, the worst vintage median return is about 5%, and it was in kind of 2005, 2006 before the financial crisis.

So even leading into the financial crisis, secondary funds still posted a mid-single digit IRR. The upper quartile is often somewhere in the high teens for mature benchmarks. But if you think about how our industry is achieving those returns, it’s being done with hundreds and hundreds and hundreds of companies. Secondary funds might buy a portfolio of 20 or 40 funds that have 200 or 300 or 400 businesses in it. So to be able to generate consistent mid-teens performance with tight top and bottom quartile benchmarks between 9 and 18 and having a very low loss ratio as an industry, it’s just a really attractive asset class on a risk adjusted basis. The last feature that I think LPs like about it is the best years are the years where there’s stress in other parts of their portfolio. 2009, 2020, 2022. When stocks and bonds are choppy and volatile, we have committed capital as an industry to purchase funds and maybe we’re able to pick up great funds at 80 or 85 cents instead of 90 or 95 cents.

So you have this asset class that does well in all market environments, has a low loss ratio, tight benchmarks from a top and bottom quartile perspective, and it outperforms when stocks are under stress. That is a great diversifier inside of an overall portfolio and it’s a great diversifier even inside of your private equity portfolio. I think one of the trends recently is as you build a private equity portfolio, you need to consider buyout funds. And inside of buyout funds, small, medium and large. Venture, seed, early stage, growth, late stage, infrastructure, real estate, secondaries, private credit, that a liquid part of the pie chart, even if it’s only 10% or 20%, there’s actually a pretty vibrant selection of options inside of that part of your pie chart. So we think that the investors that have been putting about a hundred billion dollars per year into the secondary industry for the last few years, just really like that diversification, that consistent cashflow stream, the reverse J curve and the early de-risking that they get from early distributions from secondary funds.

Stewart: There has been a trend toward GP-led secondary deals. Can you talk a little bit about those transactions and what makes them interesting for private equity fund managers, their LPs and secondary buyers?

Adam: This is a key trend and I think it’s important to talk about because a lot of people think of the secondary industry as a pension fund has 10 funds, they hire a bank, they get bids on those 10 funds and they transfer those 10 funds as traditional secondaries on the secondary market. That’s what we did as an industry from 2002 to probably I’d say 2015, 2016, 80% to 90% of deals were just traditional secondaries. Great way to make money, made sense for buyers and sellers and that’s what our market was. I think in recent years the general partners, the fund managers themselves have thought more about their businesses. They’ve thought about the general partnership entity that makes up their firm and the fees and carried interest that flow through it and what the value of that firm is. And I think they’ve looked more deeply at their historical funds with an intention of managing them more actively than the industry used to do.

I think there’s always been a challenge in private equity where the new fund is kind of the shiny object. The new platform deals that that manager is doing are the exciting ones. They’ll highlight the top exits in their historical funds, but often not focus on some of the older assets. There’s also been an issue where private equity fund managers would sell their very best business too soon to put points on the board for their next fundraise. So the four to five year fundraising cycle for buyout funds has resulted in often letting go of a really high momentum asset at a three or four times multiple to catalyze the next fundraise. And there just hasn’t been a mechanism inside of the private equity industry to own a business for 10 years or longer. That’s how a lot of families have compounded their wealth over time by owning companies for decades and harvesting those cash flows, and private equity managers often sell the business up into a public company or to another private equity fund instead of retaining some of those really high momentum assets.

So the GP led or general partner led part of the market has arisen to help fund managers deal with their older funds and deal with some of their best assets. The two transaction types that make up most of this market, if you have an older fund that might have 3 or 4 or 5 businesses left in it and it’s 8 or 10 or even 12 years old, you can approach the secondary market and get a bid on that fund that can be taken to all of the limited partners of that fund. So instead of just a one-off trade where we might be working with a pension fund to price their interest of 1% or 2% of the fund, they get a bid on the whole fund and it’s optional and you bring it to all 50 or 100 limited partners and say, “Hey, we ran a tender process. These were the winning bids. We got a fair price. There’s enough purchasing power to buy the entire fund if everybody wants to sell.”

And you let the investors have that option and cycle out of that fund in an organized fashion. So that’s a fund tender. The continuation vehicle structure is what’s used for those high momentum assets. So instead of a fund that’s old, you might have a fund that’s only 4 or 5 years old and there’s a really high-flying business in it that’s achieved its base case quicker than expected, but it’s got a lot of room to run, don’t sell it to another private equity firm, just keep it. And the fund managers have realized that the secondary market is the tool to do that. They’ll raise capital from secondary funds for one business and take that bid to their existing limited partners and say, “Would you like to cash this out for a 3 or 4 times return? Or would you like to roll along with us in a continuation vehicle?” And they take the asset out of their fund, they put it into a fund on the side that holds just that company and all the secondary funds come in to cash out the limited partners that want out. Anybody that wants to continue to participate moves over into the continuation vehicle and the manager has essentially sold it to themselves. They’re resetting the investment period and they’re able to own that company for another 4 to 6 years. This has a lot of benefits. It should lower loss ratio in the industry. The manager already knows the company, there should be no skeletons in the closet. They know if the management team gets along or not. They know the board dynamics, they know what the M&A pipeline is, they know all the opportunities in the manufacturing plants or whatever the business model is, and they’re able to just very seamlessly continue to run that company.

Not every continuation vehicle is well-structured. You have to have a great investment bank that runs a fair process. The dynamics of the transaction need to make sense. The sponsor still needs to be the right owner of that asset. So there’s a lot of bells and whistles that come with these transactions. But it’s going to, we think, bring some pretty exciting multiple of invested capital to our industry. If you think about what traditional secondaries offer, that might be something like a 1.5 to 1.7 times multiple and a mid to high teens IRR if our industry does our job right. Because you’re buying assets that have already had some value accretion in the past, the whole period is shorter and thus the multiple is a little bit lower. Well, with a continuation vehicle, this is a brand new investment period for a single company.

A lot of these transactions, the general partners think the assets have another 2 to 3 turns of invested capital to run, and these assets are now going to be found inside of secondary funds. We’re picking off as an industry, the top 100 or 200 businesses each year that sponsors want to hold onto. In the past, these would be sold up the chain to bigger private equity funds, which would generate a lot of LP, limited partner co-investment. Instead, some of these top assets are being captured inside of secondary funds, and we hope that by having a fund or having an industry that puts about half of its capital into cashflowing secondaries that are a little bit shorter duration and about half of its capital into these 4 to 6 year hold single assets or multi-assets that have a little bit of longer duration, it’s going to really improve the benchmarks of secondary funds, will still hopefully have a similar attractive IRR, but a little bit more multiple of invested capital for the investors that participate in secondary funds. So it’s a key trend. It’s happening right now and it’s something that we’re definitely excited about.

Stewart: That’s really helpful, Adam. And I mean, you talked about the evolution of the secondary market over the last 20 years, and obviously there’s been a tremendous amount of change and a tremendous amount of growth. If I can get you to dust off the crystal ball over there, what’s the secondary market look like 5 years from now?

Adam: There has been a lot of debate amongst our peers and at the secondary industry conferences about where can this industry really get to. And I think we’re all pretty bullish because the bigger the secondary industry gets, the better it’s going to be for the blind pool buyout and venture fund managers because they will be able to raise more money if the limited partners perceive more liquidity in the market. So it’s hard to raise a billion dollar fund if you think you’re going to be stuck in the fund for 15 years, but it’s much less stressful if you know that on any quarter end you’re able to get a bid on that fund and make a decision to either stay or to sell. So we think it makes sense that the industry grows, it’s going to have to come from additional interest from the limited partner community to fund secondary funds.

We are in a period right now, and this is good for returns and good for… it’s keeping pricing down, but our industry is very short on capital. The last survey suggested that the secondary buy-side has about $130 billion of raised capital that hasn’t yet been spent, and about 80% of secondary funds out of the 100 are raising new funds right now trying to pull in roughly another $90 to $100 billion. That’s great. But we’re an industry that could trade between $100 and $150 billion per year today. We usually would hold about two years of dry powder as an industry versus annual volume, and it’s much closer to one-to-one right now. That is a significant shortage. It’s happening simply because the same institutional limited partners that invest in secondary funds are the ones that are over allocated to private equity because their stock and bond portfolio fell at the same time in 2022 and into 2023.

So I think as we just increase the level of knowledge of the limited partner community and increase their interest, and with the rise of GP led deals, bringing some additional multiple of invested capital to our industry, I think that we’ll be able to raise $150 billion a year and deploy it, raise $200 billion a year and deploy it, raise $250 billion. And if we as an industry can convince the institutional investor community that secondary funds have a permanent place inside their portfolios, inside of their illiquid alternatives allocation, we’ll have done a good job. Secondary funds for a long time were used by investors mainly to ramp a private equity portfolio that was either new or way behind target because secondary funds get the money invested quickly, then they pump out distributions quickly, and those distributions can go into other commitments that are made. But then some investors would not continue to re-up with secondary funds because they felt like they didn’t need secondary funds in a mature portfolio.

We think now with the return profile improving because of GP led deals, a lot more institutional investors are going to keep a permanent allocation to secondary funds alongside their buyout commitments, their venture commitments, and their private credit commitments. And as soon as we raise more money as an industry, we’ll have more to deploy. The industry overall will feel more liquid. We still think we’re in the early days where there’s going to be a lot of alpha, but more fundraising and more deployment is going to be positive for everybody, and we’ll hopefully be transacting north of $200 billion a year 5 years from now, maybe even higher than that. I think that’s going to be an exciting development.

Stewart: Absolutely, and I’ve learned so much today and I really appreciate it. I know our audience does as well. I got a choice for you going out the door, you can choose either or both, no pressure. Lots of people choose both. What’s the best piece of advice you’ve ever gotten and who would you most like to have lunch with alive or dead?

Adam: Two interesting ones that I was unprepared for. This sounds simple, but I came up through investment banking. I worked at a direct private equity firm, did full-time business school, have now done this for 10 years and even before investment banking, just always worked hard. When we recruit at 50 South Capital, we’re looking for smart, hardworking, intellectually curious people that are just good people. And I think there’s nothing that can take the place of hard work and hustle. This is an industry where we have to fundraise, source deals, underwrite deals. There’s a ton of work to do, but with that great work comes a lot of pleasure and I think I’ve just learned from my parents and a lot of mentors over the years that no substitute for hard work. So that’s what I’d say there.

And then I’m fascinated by Elon Musk. I could probably pick some interesting historical… I mean Archimedes. There’d be some tremendous people to meet over antiquity, but I’m fascinated with his interest in getting us off planet and just really find what he’s doing across all the businesses. Very interesting. He’s involved in a lot of venture capital investments that we have, so we have some ability to track what he’s doing, but just a very interesting public figure at the moment.

Stewart: Very cool. I really appreciate you being on, man, and I’m 100% with you. I mean, we were talking, I got a note from a CIO yesterday asking me about someone who was… that I knew, and essentially it’s a preference for work ethic and character over GPA. I think GPA is not a great indicator of success. When I taught, we used to get people come in and they’d say, “Oh, I was a history major with a 2.7, but I want to hire finance majors only with 3.5 or better.” And it’s like, “I’m not sure that that’s necessarily…” I get why the screen exists, but I love your answer that there’s no substitute for hard work and there’s no substitute for strong character. So good stuff.

Adam: Yeah, integrity and empathy are fundamental, and then hard work on top of that is a good package, I think.

Stewart: Absolutely. We’ve been joined today by Adam Freda, managing director at 50 South Capital. Adam, thanks for being on.

Adam: Thanks, Stewart.

Stewart: Thanks for listening. If you have ideas for podcasts, please shoot me a note at Please rate us, like us, review us on Apple Podcasts, Spotify, Google Play, or wherever you listen to your favorite shows. My name’s Stewart Foley, and this is the Podcast.

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Northern Trust Asset Management
Northern Trust Asset Management

Northern Trust Asset Management is a global investment manager that helps investors navigate changing market environments, so they can confidently realize their long-term objectives.
Entrusted with $1.1 trillion in assets under management as of June 30, 2023, we understand that investing ultimately serves a greater purpose and believe investors should be compensated for the risks they take — in all market environments and any investment strategy. That’s why we combine robust capital markets research, expert portfolio construction and comprehensive risk management in an effort to craft innovative and efficient solutions that seek to deliver targeted investment outcomes.
As engaged contributors to our communities, we consider it a great privilege to serve our investors and our communities with integrity, respect and transparency.

Chris Doell, CFA, CIA
Director—Insurance Practice

Andrew Coupe
Director—Insurance Solutions
50 S LaSalle St
Chicago, IL 60603

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