One of the main challenges institutional investors and OCIOs face today is ensuring longevity of favorable returns from their private equity and venture capital investment programs. Following 2021, both returns and distributions/returns of capital from those investments have fallen sharply. We have written about the return challenges in prior Briefings that are posted on our website www.manageranalysis.com. In the last year, distributions/returns of capital have started to increase which could be seen as favorable. However, we believe that over 1/3rd of all distributions now come from events where the private equity manager [the GP] retains their control of the companies sold, using continuation vehicles or GP-led secondaries. Adjusting for these GP-led efforts, “true” exits may actually be continuing to decline.
This Briefing continues our exploration of key themes in private equity and venture capital allocations, where Secondaries funds offer an alternative way to invest in privates.
I. Private Equity Secondaries require a closer look
Many investors have now asked us to opine on various fund offerings by Private Equity Secondaries funds. These funds have become incredibly popular investments over the last few years with assets currently invested at $700 billion, “dry powder” of $300 billion in 2025 and fundraises of $120 billion in 2025 according to Pitchbook’s 2025 Global Private Markets Fundraising Report. For asset owners that are new to private equity, secondaries funds may also offer immediate diversification across managers, sectors, and vintages.
A typical pitch to asset owners is that the new fund has a premiere private equity secondaries manager running it with great access to attractive assets for sale. Most compelling, the new fund already has a very high IRR, and prospective investors historically appear to respond to that enticement by subscribing before the fund’s subscription period ends.
Marketing in Private Equity Secondaries frequently contains obfuscations that are important for investors to identify and understand, and we assist investors in that effort. In some cases, we find compelling opportunities, but in most situations, we advise against these investments. One of the most critical hurdles is that the private equity secondaries manager should add more value than their management and carry fees. We usually think of those fees cumulatively costing 8 to 10% of the value of a secondaries fund over their full life, which is a high hurdle to cross but one that good managers have been able to do.
Key facets we like or avoid are:
We believe that, to assess the investment opportunity of a private equity secondaries fund, it is important to understand the dynamics of the “Inverted J Curve.”
II. Explaining the “Inverted J Curve”
The J-Curve occurs in private equity investing, where the private equity manager acquires portfolio companies while typically incurring large upfront diligence and restructuring costs for the acquired companies. Initial returns may be low or even negative for the first few years, but usually rise sharply when the fund is fully invested and portfolio companies’ earnings improve under the private equity manager’s supervision.
Source: Hamilton Lane Knowledge Center
The “Inverted J Curve” for private equity secondaries reflects the awkward and problematic utilization of the “practical expedient” accounting method, which is the most common valuation practice used for private equity secondary funds. It simply accepts the value stated for each underlying fund investment, as provided by each of the fund’s many private equity managers. Thus, if a private equity secondary fund purchases a $10 million fund investment at a 30% discount for $7 million, the accounting practice is to recognize that $3 million discount as an immediate gain. Since most private equity secondaries are purchased at a discount to their stated value, the net result is that new private equity secondaries funds will demonstrate a very high initial IRR. That IRR will usually go down over time, as the private equity secondaries fund becomes fully invested and no longer realizes these instantaneous gains, and as reasons for the initial discount like application of secondaries fund fees and weak performance of holdings manifest themselves.
The real challenge is that the discounted prices often reflect actual weaknesses in the underlying holdings or their managers. Over time, the example of a 30% discount may cause future returns to be, for example, 6% lower than the average private equity fund over roughly 6 years. Adding to this future drag on returns is the second layer of fees that private equity secondaries managers charge investors. The net result can be a substantial under performance compared to other alternatives the investor could achieve elsewhere.
Relying solely on IRR calculations to understand private equity secondaries’ managers’ performance is fraught with hazards, the biggest of which is that funds that use the ”practical expedient” accounting approach. This approach implicitly assumes a full recovery of discounted values, while ignoring potential problems with underlying holdings that caused the discounted valuations in the first place.
Following are some anonymized examples we share from our research on behalf of clients. Of serious concern for investors is that some of the state returns we examined are substantially inflated: when we compared the IRRs investors received with the IRRs stated in the funds’ marketing materials, we found the actual IRRs can be 3% to 5% per annum lower. Treatment of leverage, timing of investment cash flows that do not align with capital call dates, and treatment of refunded capital calls all appear to favor IRR inflation in reported fund performance data without benefiting actual cash returns.
The following graph reflects anonymized, indicative performance, derived from of three private equity secondaries funds we initially examined five years ago:
Fund A performance is derived from a fund managed by one of the very largest private equity secondaries managers in the marketplace. Their use of the “practical expedient” practice is obvious in the first year of Fund A’s performance. Since the fund was then still open to new investors, the manager could seek to impress prospective investors with the very high initial return. After the strong first year return, the average annual return of Fund A was actually close to zero, with the ultimate 11% IRR through 2025 almost entirely reflecting the first-year gain.
Fund B performance is derived from a fund managed by a value-focused boutique manager. Their use of the “practical expedient” accounting is also obvious, but future returns are much better, and they outperformed Fund A by about 7% per annum. Fund B’s manager focuses on cherry-picking to acquire interests in stable, well-capitalized private businesses with strong fundamentals. Their approach is allowing them to miss the SAAS-apocalypse and they continue to perform well.
Fund C’s performance history differs in that Fund C avoids the enticement of the high initial IRR print. Fund C does not use the “practical expedient” accounting method and instead amortizes the discount over an expected life of the holding. They also take a more active role in valuing each holding to override reporting provided to them, if Fund C’s manager’s value is lower. Fund C’s manager is a very large private equity manager that seeks to understand all of the underlying portfolio companies. Before a secondary private equity portfolio is shown to them, they already have performed meaningful diligence on the majority of private companies in the portfolio, and know each of those companies’ management teams. Their approach causes them to pass on many opportunities shown to them, so they can focus on where they are seeing better opportunities. Fund C’s five-year returns are twice the returns of the “asset-gatherer” Fund A, reflecting Fund C’s manager’s prioritization of investment diligence over asset gathering, which is reflected both in their fair valuation approach and excellent investment returns.
III Conclusion
Understanding performance drivers and management philosophy in private equity secondaries markets is just as important as in other alternatives markets. Nonetheless, we continue to be surprised by the dominance of “asset-gatherer” managers in attracting investor assets into private equity secondaries funds, while using the very misleading “practical expedient” accounting practice. We expect many investors to be disappointed by their secondaries allocations, while diligent and skillful investors will achieve satisfactory results.
Should you wish to discuss assistance in due diligence of a secondaries strategy, review of an OCIO, or just want a second opinion, please call us at 917-287-9551 or email us at cutler@manageranalysis.com.
The analysis presented here is the sole opinion of Manager Analysis Services (MAS). Any investment decision should be made with reference to one’s own risk and return objectives and in counsel with one’s advisers.