Secondary Liquidity: It's Good to Have Options
There will never be a perfectly liquid fund structure for illiquid asset classes.
Illiquid and semi-liquid fund structures have numerous benefits, including potentially superior risk-adjusted returns. These benefits inherently come at the expense of liquidity.
Trading liquidity for exposure to differentiated asset classes often yields positive results for investors. However, if priorities reverse, investors can find themselves lost and frustrated as they search for secondary market liquidity.
Because liquidity needs change quickly, and often unexpectedly, is important for advisors and their clients to develop and maintain liquidity plans that consider the speed and price at which liquidity could be generated should the need arise.
Secondary market sales of illiquid funds have proven to be a critical portfolio management tool for institutional investors, whose deep relationships allow them to actively manage trillions in illiquid assets. Retail investors intent on “endowment style investing” stand to benefit even more from endowment style liquidity.
Limited Liquidity: A feature and a bug
A potential mismatch between shareholder demand for liquidity and the amount of available liquidity will likely always exist. In fact, it should exist.
Limited liquidity plays an important role in protecting shareholder value by shielding portfolio managers from the risk of becoming forced sellers of their illiquid assets. This is critical for mitigating certain risks associated with more liquid or traded fund structures.
An increasing number of investors are comfortable trading liquidity for access, and rightfully so. Consequently, semi-liquid products such as non-traded BDCs, perpetual BDCs, and interval funds have become more mainstream as capital raising and new fund launches are regularly expanding.
DI Wire: Stanger: Non-Listed BDCs Post Seventh Consecutive Quarter of Growth, Still Trail Traded BDCs
The Honeymoon Phase
As fund structures and asset classes fall in and out of favor, liquidity ebbs and flows accordingly.
Today, illiquid and semi-liquid credit funds continue to raise record amounts of capital and their liquidity programs are not (yet) under pressure from shareholders.
Over the past few quarters, the most popular illiquid credit funds in the market have only needed to tap into 25% - 50% of available liquidity reserves to meet shareholder liquidity demand [see Chart 1 below]. However, history has proven that micro and macroeconomic factors can easily drive utilization to new highs in short periods of time.
History Repeats Itself
As an industry, we have seen this movie before.
Beginning in 2013, we observed a similar dynamic in the then newly popular non-traded BDC space. Leading asset managers raising capital in semi-liquid credit vehicles, easily meeting redemption requests…a familiar plot (see Chart 2 below) that draws parallels to today’s funds.
Two years later, in 2015, non-traded BDC redemption programs started to gate investors, only allowing redemptions on a pro-rata basis. This dynamic would continue to accelerate for years to come with many non-traded BDCs receiving redemption requests that exceeded available liquidity by over 1,000%.
Have a backup liquidity plan
Are today’s products different? Yes. There are differences in access, transparency, manager quality, and of course the value of hindsight.
Are investors’ liquidity dynamics different? No.
Unexpected liquidity needs persist at all levels of sophistication and in all market cycles.
Accordingly, it’s always good to have options.
Building a relationship with a trusted secondary market buyer can help reduce the stress and confusion often associated with secondary market transactions.
Cox Capital has been doing this for over 4 years
We do our best to price assets fairly. We’ve completed thousands of transactions in a range that represents a premium to a fund’s NAV to steep discounts should fund quality dictate it. We adhere to strict underwriting standards and look to the public markets to inform our pricing.
We have a deep bench of operations expertise that allows us to assist with an inherently manual transaction process by leveraging industry relationships and the use of simple technology.
We are flexible and willing to discuss everything from single asset rebalancing to portfolio sales.
Please keep us in mind as you manage your alternative investments. As allocations to alts shift (increase), we look forward to playing an active role as a portfolio management tool that shareholders, advisors, advisor firms, and fund sponsors can benefit from.
Stay up to date on secondary market dynamics by following us on LinkedIn and X. Feel free to contact us directly with any questions at info@coxcp.com
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