How can investors address the liquidity bottleneck in private equity?
November 09, 2026
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5 min
Red Barrett
Managing Partner
Flexstone Partners
Rob Di Geronimo
Managing Partner
Flexstone Partners
Michael D’Agostino
Managing Partner
Flexstone Partners
The distribution drought: when capital growth gets stuck in transit
In the vocabulary of private equity, "paper gains" have always been a leading indicator of success. For nearly two decades, ultra-low interest rates and readily available leverage acted as a continuous escalator for corporate valuations. This fueled a frictionless cycle of buying, restructuring, and selling. Investors became accustomed to watching their reported Net Asset Value (NAV) climb steadily, confident that cash distributions would follow like clockwork.
But rising NAV is not cash in hand.
Today, global investors are facing an unprecedented challenge: a distribution drought. The rapid transition to a "higher-for-longer" interest rate environment has effectively jammed the gears of the traditional exit machinery. With corporate buyers showing strict capital conservation and IPO pipelines remaining tightly shut in the face of a rapid reset in the cost of capital, businesses are staying private longer and remaining stuck in manager portfolios for longer. The result is a structural imbalance: portfolios may look valuable on paper, but actual cash flowing back to Limited Partners (LPs) has slowed to a trickle, marking one of the weakest liquidity periods in recent financial history.
Relying solely on traditional exit paths in this environment means accepting that capital may be locked up for longer. There are however other exit routes available to investors creating needed liquidity to private equity owners as well as an interesting investment profile to the providers of that liquidity who stand to benefit from the current environment.
Why secondary markets have become structurally vital
In an era of capital scarcity, the secondary market has evolved from a more episodic exit safety valve for a select few highly motivated sellers typically experiencing some sort of portfolio distress into a permanent, sophisticated pillar of the global private equity architecture, accessible to a wide variety of private equity investors. As institutional allocations to private assets continue to grow, the private equity secondaries market is setting records 1.
The mechanics of this market rely on two distinct operational engines: traditional Limited Partner (LP)-led trades and General Partner (GP)-led continuation options.
The secondary portfolio mix: illustration
LP-Led Transactions
- Purchased around Year 6-7
- Bypasses the early J-Curve
- Fast, steady distributions
- Focus on near-term cash velocity
GP-Led Transactions
- Continuation vehicles (CVs)
- Concentrated high-quality assets
- Underwritten for a 4-5 year hold
- Aligned with top-tier GPs
In LP-led transactions, secondary buyers step into the shoes of an existing investor in a mature fund, typically six to eight years into its lifecycle. Because the seller is proactively seeking liquidity, these positions are often acquired at a discount, offering a built-in buffer.
"In the LP-led segment of the portfolio, we are seeking near-term liquidity and regular liquidity," notes Red Barrett. "Generally speaking, we expect a lower overall multiple on investment in an LP transaction, but faster return of capital."
Conversely, GP-led transactions occur when a fund manager rolls one or several portfolio companies into a new continuation vehicle to support further growth. These may often be among the most promising companies in the portfolio with the additional appeal that they are very well known by the managers at the time of the transaction, creating an appealing mix of strong return potential with lower uncertainty given the prior experience.
"The mix of these two transaction types, we think provides a nice risk/return and cash flow experience to investors," Barrett adds. "Really regular distributions from the limited partner transactions with a little bit of discount to provide some near-term pop, and then added return later on in the life from the GP-leds."
Beyond the discount: precision and the "mosaic" approach
In the current economic environment, a common misconception is that secondary investing is merely an arbitrage game of buying whatever is cheapest. But buying structurally weak funds and companies run by misaligned sponsors simply because the discount to NAV is high represents a classic value trap.
While transactional pricing has remained flat and highly disciplined 2, making entry discounts highly appealing, long-term capital preservation and further appreciation is driven by a completely different set of factors, namely good companies growing and ultimately exiting profitably. Philosophically, Flexstone prefers to focus on quality, and historically, has generated approximately 75% of total investment returns from post-transaction appreciation, not the discount at entry.
“As managers, while we do like discounts, we don't want to buy lower quality assets with misaligned and lower quality general partners just to be able to get kind of short-term writeups that may not persist," says Rob Di Geronimo. "Our goal is performance throughout the life of a fund."
"Discounts don’t matter as much as people think," seconds Michael D'Agostino. Real compounding depends on asset quality, which is why Flexstone pursues an active, highly targeted approach in the secondary market, rather than a “bulk buying” approach that was more typical in the industry’s early days and continues to be taken by buyers with very large secondary funds to deploy.
Instead of buying massive portfolios with dozens of interests, where a buyer cannot possibly analyse every underlying position, Di Geronimo says often a “mosaic approach” can prove a more successful approach to creating a portfolio of targeted, proactively pursued funds. This involves dissecting complex portfolios, rejecting weak or less well known assets, and bidding only on the specific underlying lines where they have absolute conviction.
This level of selectivity is crucial when evaluating different fund generations. For instance, assets purchased during the market peak of 2021 were bought at extraordinarily high multiples, making them vulnerable in today's environment. A mosaic approach allows managers to actively bypass these higher-risk vintages, focusing instead on resilient companies in the business, financial, and healthcare service sectors that feature recurring revenue streams, high operating margins, and low capital intensity.
Macro risks and the portfolio J-curve solution
No asset class is immune to macroeconomic headwinds. If central banks are forced into persistent rate increases to combat sticky inflation, debt-servicing costs will rise across all corporate sectors, dampening valuations and slowing exit volumes further 3.
"Lower interest rates, higher exit volume, those would be very beneficial from a macro perspective," D'Agostino points out. However, if interest rates simply stabilise near current historical average levels, private markets will adapt. Sponsors will adjust their leverage expectations, and secondaries will serve as the primary bridge for the capital bottleneck.
For wealthy and individual investors seeking exposure to private equity, this macro climate can make secondaries a logical entry point. Traditional primary funds suffer from the "J-curve", a multi-year period of weak returns early in a fund’s life, caused by early management fees, fund deployment and initial operational investments in companies that may take time to produce measurable value followed by accelerating returns and exits later in the fund life.4
"J-curve mitigation is a big element of a secondary programme and fund," D'Agostino points out. "LPs don't have to suffer through that negative period for an extended period of time. Buying more mature funds in the steeper part of the return curve means shorter duration with faster liquidity, and for all those reasons, it can make great sense."
The secondary market has matured into an important strategic tool. By prioritising structural asset quality over simple discounts, avoiding valuation traps from peak vintages, and building balanced, high-conviction portfolios, investors can turn today's liquidity bottleneck into a resilient source of long-term opportunity.
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Disclosures
1 Jefferies reports $118 billion in global secondary transaction volume, a new first-half record and 15% above H1 2025’s $103 billion. The total comprised $56 billion LP-led and $62 billion GP-led transactions. The market is on pace to exceed its $240 billion full-year 2025 record. (Jefferies LLC, Global Secondary Market Review, 2026).
2 Average pricing for LP-led buyout portfolios remained elevated at approximately 91% of NAV in H1 2026, compared with 92% for full-year 2025. LP portfolio pricing overall averaged 87% of NAV. (Jefferies, Global Secondary Market Review, July 2026).
3 Global buyout exit activity fell to some of its lowest levels in a decade due to macroeconomic headwinds and the bid-ask valuation spread, cementing the role of the secondary market as an alternative liquidity mechanism (Bain & Company, Global Private Equity Report 2025)
4 In private equity, the J-Curve describes the historical tendency of a fund to deliver negative returns in its early years followed by accelerating gains in the later stages of its life cycle. During the initial phase, a fund's net asset value declines because investment gains have not yet materialised, while the fund immediately incurs upfront management fees and capital calls to acquire new portfolio companies. As these businesses mature, undergo operational improvements, and are eventually sold for a profit, the fund's valuation swings upward, creating the characteristic "J" shape on a performance graph.
The analyses and opinions mentioned in this document represent the point of view of the referenced author. They are issued as of the indicated date, are subject to change, and should not be interpreted as having any contractual value.
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