By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Interesting article in FundFire today addressing the issue of a “liquidity crunch” as the over-commitment to private equity and the lack of distributions is forcing pension plan sponsors to seek their own liquidity through transactions in the secondary market. This isn’t a new issue, but one that is getting more press today. That said, we’ve seen this scenario play out many times before in our industry which has a tendency to overwhelm good ideas with too much money.

What I found most interesting is the fact that so much money is now chasing secondary opportunities (estimated at $70 billion in Q1’24), as if this opportunity were immune to also being overwhelmed. In fact, according to the FundFire article, “Secondaries took up a larger chunk of fundraising in the first quarter of this year than any other year going back to 2008.” What’s interesting about that time frame, we were dealing with a major repricing of all assets at that time. It made sense to be a provider of liquidity at deep discounts to previous valuations. However, that isn’t the case right now. Sellers (pension plans) have over committed and private equity portfolios aren’t returning capital at the same level that they’d previously done.

In addition, the article went on to say that a “potential rate decrease on the horizon, has created a greater confidence on secondary buyers putting forth a strong price for sellers.” Really? A strong price for sellers would mean to me the potential to overpay for the opportunities in the secondary market. If that is the case, future returns will be negatively impacted. Where’s the opportunity?

For plan sponsors needing liquidity, don’t be a forced seller of assets that in many cases don’t have natural liquidity. Bifurcate your plan’s asset allocation into two buckets: liquidity and growth. The liquidity bucket should be built using investment grade corporate bonds that defease near-term liabilities (next 10-years) allowing for the growth assets, including your private equity, to now grow unencumbered. Bonds are the only asset class with a known terminal value and contractual semi-annual payouts. Use that information to construct a portfolio that ensures (barring defaults) the necessary liquidity to meet the promises that have been made to your participants. With regard to the growth assets, extending the investing horizon will dramatically enhance the probability that the strategy will meet its long-term return objectives. Regrettably, most pension systems live in a quarter-to-quarter cycle of evaluation.

Lastly, before allocating to an asset class or making additional allocations, understand the natural capacity of that strategy. As mentioned earlier, we have a tendency to overwhelm good ideas. Don’t be the last one on the boat that is about to go over the falls! You want to be the seller to all those still trying to get on the boat.