In the dynamic world of institutional investing, there are numerous reasons why investors want to get out of a special fund (AIF). At the same time, there are numerous opportunities and advantages for potential new investors if they can invest in existing fund structures. However, the prerequisite for this is the existence of a suitable and sufficiently liquid trading venue for special funds. Earlier reservations are no longer in keeping with the times; rather, the existence of a functioning and regulated secondary market is only advantageous for all market participants involved.
Secondary market trading of fund units, also known as “secondaries”, has long been an established investment strategy, especially in the Anglo-Saxon world and in asset classes such as private equity and private debt. In Germany, on the other hand, the secondary market is only a common exit route in exceptional cases. And while stock exchange trading in liquid securities such as shares and bonds is completely taken for granted, it is rarely perceived as an opportunity for special funds – or is even considered a reputational risk. However, this view is no longer up-to-date and objectively incorrect: Fund units are also fundamentally fungible, i.e. tradable and transferable. The motivation of investors to enter and exit also says nothing about the quality of a special fund: Investors can also realize valuation gains through a successful exit, want to adjust their strategies and allocations or have to adjust them for regulatory reasons.
Secondaries are a great opportunity, especially for real estate
This is because the real estate landscape is changing and this change is also having an impact on real estate funds: Individual types of use such as offices and retail are fundamentally changing their concepts and, in general, there is a high need for revitalisation across all types of use in order to implement modern energy and heating concepts. If the increasingly mature real estate funds are compared with the life cycle of a property, the impression arises that the real estate asset class as a whole is in a redevelopment phase. This circumstance results in opportunities and risks for asset managers who have to upgrade or replace older portfolios. This pressure to adapt gives professional investors the theoretical possibility of adjusting real estate allocations depending on the desired risk-reward ratio and letting them “breathe” accordingly. In practice, however, this has so far been hampered by limited trading opportunities for special fund units, although these are generally easy to trade as secondaries.
But together with the maturity of the real estate fund market, awareness and understanding of the advantages and possibilities of secondary transactions is also growing in this country. Internationally, secondaries have long since achieved a significant market position and have become an important part of the investment strategy of many institutional investors such as pension funds, insurance companies, family offices and specialised secondaries funds. This is made clear, for example, by the growing global trading volume of secondaries in recent years, which is estimated to amount to several billion euros annually for real estate fund units alone. This has been made possible, among other things, by improvements in market transparency and regulations, which have strengthened confidence in the market for secondaries. From this point of view, it makes more than sense to also draw the attention of German (semi-)professional investors to the fact that there are liquid and regulated trading venues that have already established themselves among private investors, for example. The offer expands secondary market trading in Germany in the field of special funds in the long term and now also offers professional and semi-professional investors the opportunity to participate in the growing market for secondaries.
Phase-outs are often strategic in nature
Institutional investors often have very specific motives for exiting their special funds. It will be easier, shorter-term and more flexible to adjust asset allocation – regardless of whether sellers want to restructure for strategic reasons, perceive the market differently, have to allocate differently due to the denominator effect or want to adjust their portfolio for other reasons. Especially in the case of real estate funds, restructuring can make sense due to changed risk profiles due to life cycle phases. Investors willing to sell can communicate transparently for the buyers and discreetly for the public. In contrast to the return of the fund units to the capital management company, there is no reputational risk vis-à-vis co-investors with whom sellers may still be jointly invested in other funds. In addition, transactions take place faster than with the lengthy redemption of fund units, which is subject to deadlines and surcharges.
Secondary markets offer the opportunity for sales decisions to be perceived as strategic decisions and not as forced sales. These advantages benefit both fund investors and asset managers, as the liquidation of the fund through redemptions is avoided. Instead, the focus is on the strategic elements of the sale decision: valuation gains can be realized, free funds for reinvestment are available faster and more predictably. A secondary market thus creates a secure framework for special funds that reflects normal market dynamics: higher liquidity when trading fund units creates a balance between supply and demand, which in turn leads to market-driven and thus compliance-compliant pricing.
The exit becomes an entry window
However, a transaction cannot take place without there being a buyer side. For them, too, there are numerous advantages from the purchase of secondaries. New investors are given the opportunity to enter an investment that is already underway, which has a transparent track record through institutional reporting, which can mean a lower investment risk for the buyer. Risk-averse investors in particular can gain insight into all relevant key figures before the transaction due to the greater transparency, instead of having to buy a “pig in a poke” as with a blind pool. This makes it easier to determine the position of the special fund in the life cycle and to decide on preferred types of use and risk exposures.
Adherents of opportunistic approaches and value-add strategies, on the other hand, can get involved in upcoming revitalization projects that offer a high chance of value appreciation through modernization. Although opportunistic strategies on the secondary market are associated with a potential reinvestment risk, investors can get a good picture of property and location risks and opportunities in advance thanks to the transparency between the trading parties. The market balance on a liquid trading venue also leads to fair, independent and thus compliance-oriented pricing for them. There is also an opportunity for good starts: sometimes discounts offer relatively good entry prices compared to the original issue prices and thus higher return opportunities – although this is of course not automatic and must be negotiated individually.
Asset managers should actively approach secondary markets
Secondaries trading via secondary markets also offers numerous advantages for asset managers and capital management companies. When fund units are traded on a secondary market, this is neutral for the fund’s funds: buyers and sellers trade the fund units among themselves, so there are no consequences for the fund’s assets in the form of outflows. In view of the current net outflows of funds in open-ended real estate mutual funds, this is a scenario that is not entirely unrealistic even for special AIFs, which can be efficiently countered for special AIFs with the help of secondary markets. This means that the fund does not erode from within and funds for payout do not have to be raised through any asset sales – which can quickly become necessary, especially in the case of professional real asset funds that are managed with very low liquidity reserves. Special funds retain their reputation, as sales of a strategic nature no longer attack the amount of funds.
Communication among all parties, including asset managers, can take place on a broad scale using secondary markets if they actively engage with secondary markets. The use of secondary markets does not result in any new funds flowing into the funds, which is not always possible and desirable with current funds anyway. However, some buyers or the new shareholders can, if possible, bring in additional funds in a second round and expand their positions, for example to implement ESG strategies in the portfolio. This gives asset managers the opportunity to create comprehensive revitalization concepts and actively attract value-add investors with new equity, which moves the fund into the next phase of its life cycle.
The time for secondary markets is now
Market data proves the growing importance of secondaries. A report by “Secondaries Investor” shows that Europe and Asia are increasingly catching up when it comes to the use of secondaries transactions. The trading volume of secondaries has grown steadily and amounts to several billion euros annually for real estate fund units worldwide. Senior executives at Ares Management estimate the potential for real estate specialty AIFs in the secondaries market at $20 billion in the next few years. This development is supported by increasing market transparency and improved regulation, which increase confidence in secondaries transactions. This clearly shows that liquid and regulated trading venues can also be of great benefit to German professional investors, as they facilitate access to secondaries.
The possibility of secondary transactions via a liquid trading venue therefore only has advantages for all parties involved. Since buyers and sellers can thus efficiently represent their interests, a functioning and discreet secondary market model is important for semi-professional and institutional investors. Especially in more volatile market environments such as the present time, secondary markets represent an important and relevant opportunity for many investors who want or need to adjust their allocations for strategic or regulatory reasons. This allows institutional investors to comply with their requirements, while interested buyers are given opportunities to enter the market. Since secondaries are an established and growing investment strategy that is also becoming increasingly important in Germany, secondary markets close an important gap – in the interest of all parties involved and to the benefit of all parties involved: the successful exit becomes an attractive entry – without changes to fund volumes.
