What's driving the growth of private credit secondaries

There's a booming segment of the secondary's market gaining traction from buyers and sellers alike. Credit secondaries are drawing increased attention from investors seeking yield and diversification away from their private equity exposure. Over the past year we've seen several billion dollar plus credit secondaries deals emerging both on the LP side and the GP side of the market. Furthermore, a number of secondaries firms are continuing to build out dedicated credit secondary strategies. I'm Madeleine Farman, Editor of Secondaries Investor, and welcome to the latest edition of our second Thoughts podcast. In this episode, my colleague, America's correspondent Hannah Zhang, is joined by two guests who are among the earliest to step into the credit secondary space. They will unpack the evolution of private credit secondaries, the dynamics behind LP lid and GP lid transactions, and how macro effectors like tariffs are shaping today's deal-making environment. Hi, I'm Hannah Zhang, America's correspondent at Secondaries Investor. Today, I'm joined by my co-shot, Head of Color Secondaries at Color Capital, and Gerald Cooper, Global co-hat of Secondaries Advisory at Campbell Lashes. Today, we're going to dive deep into credit secondaries, as more large private credit deals come to market and an increasing number of players launch dedicated strategies to capitalize on this growing opportunity. I will let Michael and Gerald introduce themselves first. Michael, why don't we start with you? Hi, yeah, thank you, Hannah. Great to be able to do the podcast with you and Gerald, and I have known each other for a really long time, so particular pleasure to do it together with him. So, briefly to myself, I've been in that color for just about 20 years now. Obviously, we are active in the credit secondaries market, and I guess for SINs as well, me in particular, helped in a way create the credit secondaries market by doing our first transaction in the space just after the global financial crisis. It really has seen this market develop from start to finish, and I think it's a really exciting place to be. Gerald? Great. Well, thank you for having me on, and great to be speaking with you. Great to be speaking with my friend, Michael. Gerald Cooper, I'm Global Co-head of our Secondary Advisory Practice at Campbell Lashes. I've been executing and advising on Secondary Transactions since 2004, so I've been in this market for a long time. Campbell Lashes has been advising on Secondary Transactions since 2000. We actually did our first credit secondary transaction fairly early on in Europe back in 2016, but the market sort of really took off in 2021 or so. We've done several large groundbreaking secondary transactions, both on the LP-led side and the GP-led side. We've seen a ton of capital come into the space. It's an area that we intend to really focus on in the future, and we're excited to talk about it with you. All right. Thank you both. I like to start by setting the scene for private credit secondaries, which remain an emerging part of the broader Secondary's landscape. Let's spend a bit of time discussing how private credit secondaries have developed. I'm also curious to hear how each of you begin your journey in the space and what experience has been like. Let me kick off. Obviously, in a way, the evolution of the private secondaries market for credit, it's always driven by the evolution of a primary market. You need a big primary market to have a functioning secondary market, because in the end, it is a derivative of a primary market. Obviously, what has happened in private credit is that that market has really grown very, very rapidly since the financial crisis, in particular with regards to senior-dairy lending as a close-ended fund activity. So, that market has grown from almost next to nothing to an industry that's now 2.5 trillion in size. So, as you talk about a very, very significant primary market, and we, as a secondary buyer, obviously provide liquidity in the market. So, I think what's really exciting is that that private credit primary market, it is forecasted to still grow very rapidly. It's the fastest growing alternative asset plus, and I believe that will continue for the next decade. It's also to come. It's a secular shift from bank lending to fund lending, and that market was depending on how you define it as the potential as a primary market to be significantly bigger in my view than private equity. And some people already talk about it as a market that is 15 to 20 trillion in size, if you look at all the assets that could go into the primary market. So, you have very exciting from that perspective. Yeah, I can add on to that. Agree with everything, Michael said, the private equity secondary market represents about 2 to 3 percent of everything that is raised in the primary market. And on the credit secondary side, that's under 1 percent. So, there's much less churn in credit secondaries, and a lot of growth still to be had. When I got involved in the secondary market back in 2004, transaction volumes were 7 or 8 billion, and now they're 165 billion. So, the broader market has grown, and credit secondaries, no doubt, will be following that trend. One of the interesting things about this dynamic is that as more buyers come into the space, it draws out sellers. So, back in 2004, we were speaking to Collar, and maybe a handful of others, probably 12 to 15 secondary buyers that were actively acquiring private equity secondary interests at that time. That number has now ballooned to close to 100 groups that have dedicated capital looking to buy private equity secondaries. And as the number of buyers has grown in the space, we've seen the number of sellers has increased. They've seen that there's a market there where they can actively manage their portfolios. Credit secondaries have been around for a while. The problem that we had originally, though, and I would say only kind of six or seven years ago, is you had a lot of equity investors that were trying to extract equity returns out of credit positions, which led to a very big, or I should say, a wide, bit-asks spread. And with those material discounts, you saw trading volumes pretty low. Over time, with the help of Michael and some others in the market, capital has come into the space that is right-sized for the opportunity. They're seeking returns that are more appropriate for the asset class. As that's happened, that bit-asks spread has narrowed discounts have gone lower, and prices have been better, which have been more enticing for LPs to use the market as a tool to actively manage their portfolios. As we see more buyers come into the space, we'll see the churn within the primary markets increase, and undoubtedly, we are going to see a growing private credit secondaries market. And maybe if I can just add, I mean, I still remember that transaction that Gerald mentioned. Their first credit sentence, which we didn't do, even though always we've got a great relationship with them and really understood the situation well. But at the time, we didn't have the right cost of capital for that type of transaction. And most other people invested out of our equity fund in credit transactions. So transactions like this that happened, in a way, really drove us to raise dedicated capital for the strategy, because we say, look, these are attractive transactions, but they obviously don't deserve an equity-like return. They deserve a credit-like return. And I think what now sounds pretty obvious to everyone that makes a lot of sense. I think when we raised our first dedicated fund, I don't think it was obvious. Thanks, Michael. That's a great point about the shift toward raising dedicated capital. And just putting on that, I'd also like to explore what's motivating sellers to come to market in a first place. Let's start with the LP that site. What do you think is driving LPs to sell in today's environment? I can take that just based on the conversations that we're having with LPs. Look, private credit is still in illiquid asset class. And investors in this space, they have dynamic circumstances. So you have changes in leadership. You have changes in portfolio management strategy. You have investors that are trying to match assets and light abilities. And you've got allocation issues. And all of those things contribute to the desire to actively manage portfolios. Also, you know, you saw this with private equity. In early 2000s, when a lot of the public pension funds were getting into private equity as an asset class, they invested in a lot of managers. And so they had these massive diversified portfolios. You know, some public pensions with 80 to 100 GPs in their portfolio. And over time, the market realized that you didn't need to have 80 to 100 managers in your portfolio. Well, we're seeing the same thing with the credit secondaries market. Or I should say with the credit market more generally. In kind of 2010, 2011, 2012, when this market really started to take off, you saw a lot of the early LPs investing in many different managers. Well, each of those portfolios, those underlying portfolios are already heavily diversified. So you don't need 30 credit managers in your portfolio to have a diversified portfolio with attractive risk adjusted returns. And so we're also seeing a rationalization within the portfolio from many of these LPs. And maybe one thing to add up in what we are also seeing is obviously while credit funds obviously shorter duration than private equity funds, I was yesterday I said they're very long duration still and within someone's asset allocations is probably one of the longest duration assets that you're holding. But despite them being somewhat shorter duration or because of that, we also see a lot of investors actually putting more duration into the investments by creating evergreens or SMAs that have a very, very long life and that are re-investing by themselves. And obviously if someone wants to then exit one of these more evergreen type of structures, again, you need a secondary provider like us to facilitate that exit because putting these things into runoff can take a very very long time. And that's a feature would say that you have more in private credit and not so much so in private equity. The other thing that I would say, and this is a little nuanced, but many of these funds have leverage. And in the early life of these funds, the investors benefit from that leverage as you get later into the life of the fund when the loans have to be repaid or the leverage at the fund level has to be repaid. A lot of the cash that would have gone to the investors is going to pay down principle. And so you go from having a really nice, levered return to more of an unlevered return as you get to kind of later in life of the fund, which can also drive an LP who wants that levered return to just kind of cap their return, selling the secondary market and redeploy that capital into new opportunities. So there are some other more nuanced reasons why why people are using the market as well. Some really sophisticated players. What about on the gps side with seeing a number of sizable credit gps deals come to market over the past year or so? What's motivating credit managers to pursue these transactions? I mean, one reason actually is just the reason that Gerald mentioned. For example, the leverage point is always something that also might drive a manager to say, look, actually, in a way, the capital structure that I have in my fund is suboptible now. Why don't I, in a way, create a new fund with their optimal capital structure and offer my investors the option for liquidity. So people that want to get out can get out or the others stay in. So my view is it on the gps side or see, there's not a boilerplate model as of yet in the market. It's really early innings. So I guess people like Gerald that way are driving what the concept concentration fund will mean in private credit because at the moment, I think it's very specific fund specific in a way still and manager specific. My view is I think a, there's obviously a justification for a very big GP continuation market in credit and that they will in principle take two different shapes or forms. Either they will happen reasonably early in a fund's life because at that point, it's just that sort of the fund is still very, very diversified. It has a lot of performing credits. So it's a performing portfolio and that is a optimal time in a way to have a continuation fund for senior focus credit, secondary capital. When you come at the end of a direct lending fund's life, what actually sits in there is, let's say there's 10 exporters out of 200 left and those 10 are typically equity. There's some things that I work out probably and some performing credit. At that moment in time, you can't really get a liquidity solution for the same cost of capital anymore because obviously it's a much more equity like return. So you then need different buyers for that type of transaction and I think every GP will need to make a call of when they basically offer this liquidity solution to investors because the reality is every direct lending fund that's out there will have a tail and that tail is not credit anymore. It's going to be equity and what do you then do with it? And it's not as easy in a way and straight forward I would say is on a private equity fund. You just say, look, I had some investments that are left for whatever reason. I'm just going to hold them forever. On credit is really that you have, I guess, a mismatch in my view of people invested in a credit fund and in year 10, they're sitting in an equity fund. What's the solution? So I think we're really interesting how it plays out. Yeah, it's interesting to see how different the GP led markets have developed in private equity and credit because in private equity, what's really driven that market forward is and what investors are looking for are kind of the best kind of trophy assets. And that's why you've got this single asset market that's really kind of grown the GP led market substantially over the past five years. And so it's concentrated positions in the best assets where GPs want to hold those assets for longer. And so they're putting them into this continuation fund. And the old investors get to cash out at nice returns and the new investors come in with visibility on additional upside. On the credit secondary side, the rationale is a little bit different as Michael's mentioned. It's really about solving for that tail end solution. So a lot of the GP led transactions that were involved in, it's later in the life of the fund. The GP, you do have that dynamic of kind of leverage coming down in the vehicle. And so putting this into a continuation fund allows you to recapitalize the structure and offer better returns on a go-forward basis. But it also allows these managers to provide optional liquidity to their investors. And for GPs and that market, the primary credit market continues to grow rapidly. And so for GPs that may be raising their next fund, it allows you to return capital to your LPs. And then those LPs can recycle that capital into newer ventages into that next fund that the GPs is managing. So it truly is a portfolio management tool for a lot of the GPs that we're working with. And there's an extraordinary focus on ensuring that these continuation funds, so selling these assets from the old vehicle to the new vehicle doesn't impact the track record. And so we spend a lot of time with our clients modeling out where the deal should price and ensuring that that price is going to crystallize a return that's consistent with what they've told they're going to deliver to their investors. So I think the the box within which these credit GP led continuation fund sits is a little bit more structured than what we see on the private equity side where the rationale for those transactions tend to be a bit broader and and wider. Gerald, I know you've advised on some pretty innovative deals and structures in a credit secondary space. Could you share some of the most common transaction types you've been to see in a market recently? Well, look, I mean, you raise a good point. In addition to providing tail end solutions, we've worked with a lot of groups that have created managed funds. And so they've used the secondary market as catalyst to either spin out from a captive situation. So it's a captive GP that's looking to spin out and manage third party capital and take their assets with them. And so that's one type of transaction that we've executed on a fair bit. And it's been really effective in luring in quality LPs that could potentially serve as long-term partners for these newly formed GPs going forward. In some cases, primary fundraising markets have been more difficult and it's taken longer for GPs to raise funds. In those instances, we can use the secondary market to try and generate staple primary capital or to negotiate some recycling provisions that allows GPs to recycle their distributions into new loans. And that can provide more capital for deployment, push out the amount of time that GP needs to go to market to raise blind pool capital. We've also used deferred payments as a way to bridge the gap between bid and ask in some of these situations. And private credit is a deferred payment is quite effective in private credit transactions because you can actually model out the cash flow pretty accurately because they're throwing an off-current cash. And so it can be effective in a really effective way to increase the return for the investor while keeping the optical price for the existing investors that are selling, keeping it at a level that gets the deal done. So there are a lot of levers actually that we use in these transactions to achieve a sweep of objectives. And I think the beauty and the way of having been in the secondary market for a very long time and Gerald beats me by year is obviously in a way I think what we're doing is we're sort of rolling out a playbook of what you've seen in the past in equity secondaries. You're rolling it out to credit secondaries, but that obviously you're doing on steroids in a way. So it's happening obviously much, much quicker because obviously most of these things in some shape or form we've done in the past already. For example, I think the first transaction that Gerald and I worked on together was actually a spin-out of a team from a financial institution. It brings back memories. So exactly. And that is I forgot. I think that happened around the time with the global financial crisis. Correct. Yes. And we had to take two bites at the apple to get that one done. Yeah. It's actually sorry if there's an anecdote quite funny. It is the reason why I always use the underground going to meetings in the London city, which is we had a group meeting back then. All parties meeting as of lawyers, advisors there. And it was we and actually one of my colleagues from the credit team decided to take a taxi from our office to the cities 5K. It was really bad weather and it took us two hours. And back then I guess we were a bit more junior and we arrived late and everyone was waiting for us. So it's one of these things. I think that stays in your mind for a long time. Well, that transaction that transaction was character building on many levels. Yes. Well, speaking of transactions, Michael, I recently covered the news that Conor Capital acquired a 1.6 billion senior direct lending portfolio from American National. And as far as I know, that's the largest LP that credit secondary steel focused on senior direct lending to date. And I think it also raises the broader question about the future of credit secondaries. How big do you think this market could get over the next 5 to 10 years? And with the emergence of GPLAT credit secondaries alongside the more established LPAT activity, how do you see the market evolving in the next couple of years? So I think longer term, I really believe that the private credit secretary's market has the potential to be larger than private equity secondaries because obviously credit as a asset class is bigger than equity. Overall, if you look at the world, I think there's more credit than equity. And and also more credit in a way that can be packaged up in fun format. And I was he that's in the end, we're providing liquidity to things that sit in some form of fund or evergreen or structure or the like. So I think that there's a huge growth potential for this market and we have believers at color that this will be a real scale product for us. And I think Gel mentioned the growth in the market is accelerating. So Hannah, you mentioned the 1.6 billion transactions that we've done recently. In a way, I would love to say this is like the only of its kind that has ever happened. But the nice thing is actually we are seeing more and more 1 billion plus transactions that are coming to market, which is really exciting. And if you take a step back, even in 2021, when we did what was by far the largest transaction at that moment in time, we did a transaction with an insurance company in Asia, that took us roughly I think more than a year to complete. And we need to have a fundraising effort alongside it to get it done. So it was a very a huge effort to get something like this of this size over the lines or is groundbreaking for the market back then. But the market, even in this short span of time has developed so much. And I think that's really exciting. And that's why our big mantra is always I guess the more people are active in this market, the more intermediation there is. The better it really is for buyers like us, because yes, we do proprietary things. And that drives a lot of our deal flow. But the bigger the market, I think the better it is for everyone that's involved. And I think credit to Gerald also in common luncheon. I mean, they were really early mover in the space for credit secondaries and also saw this opportunity, which other intermediaries are now catching up on. That's very kind of you to say, Michael. Thank you for that. We think that there are massive tailwinds in this space. And look, I think groups like Collar are finding creative ways to raise capital as well. You know, there are a lot of innovative things going on behind the scenes within credit secondaries. We're finding institutional LPs, asset managers. They're all trying to figure out what's going on and trying to see if they can get a piece of the action. You know, for some of these larger GP led transactions, and we did a $1.6 billion GP led deal last year. We're working on some other large transactions this year. These transactions are usually led by a large dedicated secondary platform like like a Collar capital. And then we have to bring in other investors to kind of build that book and round out the syndicate because these are large checks. And the syndication process is becoming easier and easier because the number of investors that are interested in taking a piece of these deals and getting this exposure continues to grow. And every week it seems we're finding new pockets of capital that's interested in buying credit secondaries, both GP led and on the LP led side. Credit just in general is a product of scale. Most of these credit funds are large. Most of the asset managers are sitting on tens of billions of NAV. So it lends itself to a secondary opportunity that is inevitably going to continue to grow and be of scale. I think as we look kind of five to ten years down the road, we're hopeful that we're going to see more specialized pockets of capital come into the space. At the moment, I think there's a lot of demand for senior secure sponsor backed opportunities. And then you've got some demand for things that have a bit more juice of junior debt securities, but that's a small part of the market. Even the groups that have dedicated pools of capital will probably only allocate a small percentage of their funds to things that are a bit spicier on the junior end and subordinated. But there are all these different pockets within credit. I mean, you've got infrastructure debt. You've got real estate debt. And I think we're certainly starting to see these opportunities as an advisor to sell LP interests or advise GPs on monetizing these kind of specialized subsectors within credit. But there isn't a lot of demand there just yet. And I think one thing that we've seen on the private equity side that I think we'll start to see in credit is that you will have this specialization. You will have groups that form pools of capital and expertise to prosecute transactions that are a bit more nuanced and sub these sub asset classes that are a little bit more specialized within credit. Great to wrap up. I know many of our listeners have been closely following the news around tariffs, just as we have. And there's been talks of LPs potentially facing the denominator effect again as a result. And I'm curious to hear your thoughts on how the tariffs might affect the outlook for deal making, particularly within the credit segment space. I mean, I don't think LPs are panicking just yet because it's really it's really difficult to come up with the plan when things are so uncertain. And you know, one day the market is down by 3% the next day. It's up by 6%, 7%. I think there's a little bit of a wait and see posture at this point for most LPs. If things continue to deteriorate, we may CLPs looking to use the secondary market to balance their allocations. But we may also see, and I saw some headlines this morning of public pension funds increasing their allocation to private equity or private markets so that they're not forced to sell in the current environment. I think it's too early to tell, we haven't been getting panic to calls from LPs. We certainly are having conversations with LPs and we're here to provide advice. But I think our clients are trying to be thoughtful and pragmatic about the situation at the moment. And I think any form of volatility historically suggests that in the medium term that leads to more selling. For exactly the reasons why the child outline why people are selling because of the if things change. I don't say there's a lot of change going on that means that you re-evaluate what you have and how you want to position yourself going forward. And that leads to selling volume in private markets. I mean, I think that part is inevitable. But I really wonder, I don't think there's at the moment. I think we see that there's no distress. I was in the market. There's no one saying, look, I mean, I have to sell. And those pockets are historically, over the last 15 years have been reasonably short-lived. If they ever happen and have been very sector, I'd say specific rather than they broad-ranged sell-off like we saw in the global financial crisis. And I think it's really important for everyone to understand that it was in the Secretary's market, it's not a market for distressed sellers. It's just a regular, fungely market that always has a long-term growth trend, but always has its fluctuations and due flow and liquidity like any other market that we know. Yeah, that's a great point, Michael. I mean, when I first got involved in this market, I thought it was going to be counter-cyclical offering, but the reality is it's very correlated to what's going on in the broader markets and the public markets. When the public markets are up, discounts are narrow, and opportunistic sellers actively manage their portfolios in the secondary market. In times of distress, because the private markets, for most LPs, it's grown over time, but most LPs are not in a position where especially larger LPs where they need to sell their private markets exposure. And so a lot can sort of, many of those LPs can wait until the right time to sell, and they typically avoid trying to take these big losses when we have these massive downturns. And that's what happened during the global financial crisis, that's what happened during COVID. And if you look, if you were to look at a chart that showed transaction volumes peaking, you would see that it's always in a bull market where you have the most transaction volume. And it's highly correlated to where you see increases in pricing and lower discounts. Private credit follows the same trend. Great. Thank you both for such a thoughtful and fruitful conversation. A lot of what you've shared on the private credit side really aligns with trends we're seeing in the private equity secondary space, especially around the impact of tariffs and the public market volatility. I'm sure our listeners will find this discussion incredibly helpful. And thanks again for joining me. Well, thank you for having us. Good fun. Thank you. Hello. That brings us to the end of this episode of Secondaries and Vestors Second Thoughts podcast. As the private credit secondaries market continues to gain momentum, we look forward to keeping you updated on the latest trends and insights shaping this fast evolving space. Subscribe to get notified of our regular Secondaries episodes coming to you twice every month. You can find us wherever you listen to podcasts or go to secandriesinvestor.com Ford/podcast. If you have any interesting tips for the podcast or you'd like to get involved, do get in touch by sending us an email, [email protected]@pei.group. 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