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A secondary fund of funds is an investment vehicle that is generally used among alternative portfolio managers, including private equity or hedge fund professionals. To understand a secondary fund of funds, it is useful to grasp the role of a fund of funds portfolio. This type of investment vehicle gives individuals and institutions diversification by providing exposure to multiple different funds that may be overseen by different managers and firms. Secondary funds trade in a market other than the primary market. This platform allows investors to buy or sell assets, trades that might otherwise be impossible or take a longer period of time to perform in the primary markets.
The nature of the assets purchased by private equity and hedge fund managers is often illiquid in nature. As a result, these positions cannot easily be sold and converted to cash. Instead, these alternative money managers generally invest in certain categories with an expectation to hold those positions for several years. In some cases, however, firms need to cash in early, either to satisfy the demands of clients or to generate liquidity for some other reason. Bypassing the primary markets can be especially useful, and this is where a secondary fund of funds might be traded.
One benefit for selling a secondary fund of funds for the original owner is that the firm cashes out of positions and generates income. A buyer of one of these funds may be able to obtain certain exposures at a discount versus the cost to purchase similar assets in the primary markets. There are different reasons for attempting to unload a secondary fund of funds. For instance, it could be that the owner is experiencing financial hardship or investors have asked for financial withdrawals. Market participants are often keen to use a trading platform that is transparent where all participants are identified so that fraud is avoided in a market that is non-conventional.
While the secondary markets are a non-traditional place for transactions to occur, so too are fund of funds unique. A customary private equity and hedge fund firms oversee individual portfolios on behalf of clients. On the other hand, a fund of funds manager obtains ownership in a number of other money management firms. As a result, these portfolios could be especially difficult to sell in a hurry because of the combination of various assets tied to numerous managers. The secondary markets could make the liquidation process more attainable for fund of funds.