If you ask someone on Wall Street the question if rising yields are an issue, you would get an answer that changes by the hour. Some would point to the fragile geo-political situations around the world that affect the way investors see treasury yields. Others would point to the rising debt levels and the ever-increasing interest burden. Some might even say that printing your own currency might have some unintended consequences at a rapid pace. But whatever the reason might be, we do know that rising yields might have some cause for concern across the secondaries marketplace. But on the flip side, it also serves as a catalyst for increased activity from the fear of what the future might hold. I call this period the “What’s Next” period.
Everyone feels like they have an idea as to what might be happening, but the small list of 10 macro issues occurring across the globe as put out by Bloomberg is a pretty comprehensive list. I agree with this list and I feel most of you reading would agree with it as well.
But now if you look closely and see which reasons matter the most for the secondaries marketplace, there are very few reasons that matter. This would be “changing ownership” and “savings glut erasure.” As a person who is just plugged into the market constantly, I feel all of them matter in their own way but I want to hone in on structural issues that might be catalysts to the industry.
Alright, let’s turn the clock back just a few years ago to the beautiful year of 2016. I remember that day when President Trump got inaugurated for his first term. You could say this was quite a new turn for the country, with the Tax cuts and Jobs Act just passing the House and Senate. Glorious days were ahead for Wall Street and with rates being as low as possible, anything and everything made money. It was quite funny, but again, there were sour spots across the spectrum, but overall, we could classify that period of cheap money as some of the best times for the secondaries space. It was also a period before Covid, before the federal debt exploded. I would say this was the period of “Oblivion.” Honestly, if I could go back in time, 2016 is the year I would love to go back to.
Now, you might be asking why I am bringing 2016 up. Well, for starters, I think this was the last point in a cycle where the US government could have brought back federal debt levels down a bit, but they chose growth over paying down debt. Not a bad trade off, but you create this crazy vicious cycle where growth is brought with every marginal dollar printed and sold in the form of US treasuries. Not to say, it’s a bad thing, but this strategy does have some unintended consequences that lead to asset inflation. This is where my argument comes together.
So, let’s look at “Changing Ownership” as Bloomberg outlines, this is the ever-increasing changing owners of US treasuries. With the shrinking number of pensions and institutional owners who need long-dated cashflows for their fixed obligations, the share of US treasuries now in the hands of short-term players is quite an interesting switch up. Again, I still believe that there are plenty of institutional owners who would look at a 5% 30-year fixed and buy it in a heartbeat to cover a marginal portion of their liabilities they need to satisfy. It also helps that the US treasuries market is one of the most liquid forms of investments in the world. I would think twice before buying a UK gilt or a German bund, but a US treasury has always been the gold standard. It was a status that was once enjoyed by the UK gilts and prior to that, the Dutch Losrentens, but now the US treasuries hold the crown. So, why would people want to give up the king of government debt? There are a number of reasons for this, from the ever-growing space of private credit to the direct lending market or to the fact that there are enough and more esoteric solutions to mimic debt-like yield with either structured capital solutions such as structured notes with fixed floors or floaters. Whatever your spice tolerance, Wall Street’s got a product or can whip up some esoteric randomness. Either way, you can cover your 5% liabilities with ease while even pushing to capture some of that growth as well. So, why would they buy US treasuries when pre-2023, these instruments were yielding anywhere from 3% to 3.5% on the long end.
Second, let’s look at “Savings Glut Erasure.” To put it simply, Covid stimulus around the world created a savings boom along with the closure of normal daily activities. There was an amazing chart from BofA of the bank balances in their customer accounts and how they have been slowly errored. Now, Covid was 6 years ago, and the last stimulus check was in 2021. So, this savings glut erasure seems arbitrary, but I notice an interesting thing. As the number of people working gig/part-time employment increases, so does the reduction in savings in 401(k) and similar tax-advantaged plans. This was the single biggest driving factor that applies to the inflows that large ETFs such as the SPY and VOO experience. These large inflows are also what props the S&P 500 to new levels every year and why US treasuries are losing their prominence in people’s retirements. Now, we can argue the morality of pensions and the destructive reality of 401(k)s, but it’s probably a waste of time to even procreate an honest conversation about the pros and cons for each. But to reiterate the points raised by Bloomberg, this savings glut erasure from Covid has been a long time coming. The bottom end of the E-shaped economy ended their savings a long time ago, but the glut is now pushed up the chain through inflation and higher overall prices. In 6 years, prices across every product spectrum have at least doubled if not tripled in some cases. Either way, employment has remained relatively stable, albeit for structural changes that occurred post-Covid, so the top end of the E-shaped economy is relatively cleared from this.
But how does any of this affect the secondaries market, which is relatively removed from these shifts? Well, one aspect has been the valuations of some of the firms acquired by PE firms in the 2022-2023 vintages. Structurally, these are coming to their debt maturity walls soon, and with rates pushing higher, refinancing these walls will require dry powder of sizable magnitude. There is also the fact that some of these companies have had their moat destroyed by AI, but there are others who have actually built key AI solutions and pipelines generating significant ARR. But overall, there is quite a flurry of activity in the industry, which I will explain a bit down why this might never end. But it doesn’t help the situation when hyper-scalars are on a generational run to issue large amounts of debt to provide enough compute so that we can solve every arbitrary problem presented. Might as well create enough brain rot content to keep those dopamine receptors fried while serving personalized ads.
Nonetheless, this creates a slight fight for dry powder in these institutional portfolios. This fight between the hunt for the efficient portfolio creates a battle for the yield because now I can get 5% 30-year fixed US treasuries or if I believe that Google will be around for the next 100 years, I can snag a century bond yielding 6% to clear my cashflow obligations. Both are deeply liquid markets providing that nice duration and pretty solid yield but they forgo growth for inflation protection and steady fixed payments. Now, I know there are tens, if not hundreds, of instruments that can provide yield, growth, etc. But the private assets position is equally important as the public, since a lot of the beautiful asset inflation is behind the scenes. That is why, I can go out and buy a house at 7% interest rate and still on average probably make my money back and more in the long run. Key word “long run.”
Switching back to secondaries, this asset inflation helps our case because this means increased ticket sizes with increased deal making and increasingly larger pools of money at work. A diligent investor would look at this and bake in a case for these private assets to mimic their public counterparts to reach parity. Especially with new rules surrounding semi-liquid private asset vehicles being introduced to capture 401(k) wallet share. With this in mind, let’s go back to the two risks associated with rising yields that I outlined. If we are to put all this together, we can see a clear path for the convergence of changing ownership and the savings glut to lead the secondaries market to newer, more price-sensitive fund vehicles who can capture the best pricing for their respective asset pools while generating alpha. This does mean increased activity but also increased pricing marks across the board. That is why every investment bank is setting up dedicated secondaries desks for LPs, GPs, and everyone in between. It is interesting to see the movement of how the sell-side is moving to meet the demands of the buy-side and we will see more favorable dynamics that lead to even more esoteric products and risk-taking.
In conclusion, are rising yields an issue for the secondaries space? Yes and no. I say that because there is no clear way to judge the future based on the past, especially considering the structural makeup of capital has changed time and time again. We might have a financial crisis just like the housing crash of ‘08, or we might not have anything happen at all, since investors are piled in the market and driving price action. However, you look at this situation, it is an issue in the long run, but in the long run, we will all be dead.
As always, stay informed and stay safe!