← Risk in Context Podcast
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- [00:01]
A
Welcome to Risk in Context, which features conversations with Marsh colleagues, risk professionals and others intending to help you better understand key risks, build more effective insurance programs, and think creatively about risk. I'm Paul Knowles, the global head of Marsh's private equity and M and A practice. Private equity sits at an inflection point. Returns are likely to be lower than in the past, competition and scale dynamics are shifting, and new sources of capital and product forms are now changing how funds operate and how investors access opportunities. Against this backdrop, opportunities remain significant with no reduction in the availability of attractive investments. The question is how those opportunities are captured and how disciplined entry pricing, rigorous value creation planning, and deliberate portfolio construction can help PE firms extract value and manage costs more efficiently. From a risk and insurance perspective, the environment places even greater emphasis on protecting value at every stage of the investment life cycle, from diligence through exit. In today's episode of Risk in Context, I'm joined by two colleagues from across Marsh. John Romeo is the global head of Oliver Wyman's private capital business and Benny Bauman is Mercer's global head of secondaries. We will discuss some of the top risks that the private equity firms should be aware of and share strategies for addressing them effectively. This podcast will be released just prior to Super Return, one of the industry's largest global gatherings of private capital professionals from around the world. Marsh colleagues including John and Benny will be present at the conference, sharing insights with the attendees. But can I quickly just ask John and Benny to introduce themselves?
- [01:52]
B
John thanks Paul. Great, great to be here. I'm John Romeo. I'm one of the managing partners at Oliver Wyman. I founded and continue to lead Oliver Wyman's global private capital practice, working with private equity firms, sovereign wealth funds, pension funds and other investors on fund strategy on due diligence and value creation. We work with a couple hundred investors on about a thousand deals every year. So excited to be here today.
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A
Thanks John.
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C
Benny yeah hi Paul, Many thanks for the invitation to this podcast. Looking forward to it. I'm Benjamin Bauman. I'm based in Zurich, Switzerland. Investing in private markets via primary commitments, secondary transactions and co investments for the last two decades and since 2020, I'm leading our Global Secondaries team that is active across private market asset classes.
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A
Thank you both. John, if I can kick off with you. Given your long tenure within the private sort of capital and equity world, what do you currently view as the most immediate pressure and structural themes that are impacting the private equity industry today?
- [02:55]
B
I mean, we're at a really interesting stage right now, in the maturation of private markets after a long period where we had low rates and pretty much everything went up in value, with explosive growth in the industry, the dynamics now have really shifted and clearly we've got a different interest rate environment which affects the maths on all the deals, but it's, it's much more than that. Right. And if you look at, look at the deal flow, there's just an awful lot of talk of indigestion still. The, the 20, 20, 2021 vintages have really only exited about 15% of the portfolio versus 30% which would be more typical after sort of five, six years. And so many of those are good companies, but the PE firms paid too much and they're struggling to, to exit. And so that's led to a shift in how funds have spent their time over the last 24 months. Even before you get to the impact from AI, how that's affected software blew out sort of bid offers and just made it more difficult to get that investment conviction. So you've got that deal flow on one side. You've also got a bunch of industry shape questions. The, the largest players are now accounting for an increasing percentage of AUM in the private markets. Bigger concentration, they've expanded their models, become insurers, asset gatherers, diversified financial institutions, they expanded into credit, into secondaries, infrastructure, sort of, you name it, wanting to have something to offer their LPs at every point in the cycle. And now you're getting a question over whether 100 billion is big enough to be a large fund. And then underneath that you've got all sorts of underlying changes in terms of how to use technology, how to think about the expansion of the LP base into retail, what is some of the product design and semi liquids look like a blurring of public and private markets. More transparency, more regulation coming. So it's a fascinating time right now that I think folks are still just coming to grips with all these trends happening at once.
- [04:58]
A
Thanks, John. Benny. John's really raised some really interesting topics there. When you look at that through your lens, particularly in the secondary sort of side, what are you sort of seeing as the immediate pressure points?
- [05:09]
C
Yes, absolutely. I think currently key concerns really for many private market investors globally are really around valuations generally perceived to be too high. Right. Or some instances at least. Obviously given the current macro and geopolitical and also structural risks that, that we have and see in the market. I mean, John alluded to a couple of points with regard to AI and its impact on multiple sectors. So turning to Small and mid market. In such an environment, where operational value creation is still really more prominent, valuations as well as step levels, usually slightly less aggressive, I'd say would certainly make a lot of sense to me. And then at the same time we have seen those lower distributions. John mentioned the figures from private market investments over the last particularly five years and accordingly allocations actually account for a bigger proportion of the overall portfolio. And this can become very alarming when at the same time public markets resist or decline, which is obviously always possible and which can lead then to the well known denominator effect where private investors, depending on how strict their limits are, need to sell in order to remain within certain bandwidth of the target allocation. And the lack of distributions can also lead to situations where certain concentration limits are breached, which again leads to certain pressures to sell from a limited partners perspective, but also turning away maybe from the investor to the private equity sponsors because they're also under pressure to actually distribute capital back to its limited partners, there is an expectation obviously from the limited partners for them to do so given the context I just described and when looking ahead to their next fundraising for their primary funds as exit channels via M and A and IPO were more difficult, difficult to access, they consider the option to create liquidity via the broker GP led transaction market. So this environment I think provides new secondary investors access to those assets being selected by the gps to be transferred to continuation funds and usually that really referring to their best performing assets with strong growth prospects on a go forward basis and allows existing investors actually to sell, lock in the profits and reduce their maybe overallocation to a specific sponsors and at the same time for the sponsor it creates the possibility to manage their most successful so called trophy assets for another period of growth. So I guess all those scenarios show how important secondary markets have become in today's environment and they explain the tremendous growth in transaction volumes. Secondaries actually have experienced nearly 20% annual growth over the last decade. A bit above 20% actually for GP LEDs and still high teens growth for LP LEDs. So now with that growth in secondaries, there's more thinking actually around establishing secondaries as its own asset class. I may refer to a panel that I will actually have next week in Berlin at the Super Return where I will talk about secondaries becoming a standalone asset class is actually a super interesting question. Not only academically speaking, but really also impacts how pensions, insurances, family offices, et cetera, allocate to private markets. And how as an asset managing investor actually you set up your organization, right? I Won't go into too much detail there, we'll have some time on the panel in Berlin to do that. But it's certainly true that secondaries have distinct risks and cash flow profiles that can materially differ from the underlying and they also take different spots in the overall portfolios. They're usually used with the intention to build up exposure more quickly, avoid J curve, get access to trophy assets, benefit from market or other idiosyncratic disruption. So all those factors actually speak in favor of secondaries on its own as a known asset class. Meanwhile, secondaries also have to size and scale to justify a specific allocation to the secondary. Maybe just final comment on retailization alluding to John comments there as well or democratization now it's sometimes also called which obviously also has impacted the secondaries market. Some of them are very large players actually have lower cost of capital as they need to invest at scale with certain liquidity needs. Their focus is more on LP LED secondaries usually and within that group on highly diversified performance with some tail end elements as those portfolios are usually expected to generate earlier liquidity. And at the same time I think as alluded to before as well there remains very large and fragmented market with buyer friendly supply demand dynamics around small mid cap secondary opportunities on the LP LED and the GP LED side which allows for ample value creation and very attractive returns on a go forward basis I guess.
- [10:14]
A
Thanks Benny. John, just sort of digging in from your, your sort of lens particularly around the strategy and some of the value creation piece from a secondary perspective what are you sort of seeing from your sort of world and the sort of activities you've been involved with to sort of generate the value in the secondary space.
- [10:34]
B
I mean I think secondaries are a fascinating market if you look across all financial markets. Private equity is one of the only asset classes in the world where the primary market is bigger than the secondaries and Benny talked around the strong growth but given the level of interest I think you're going to see that continue to change but probably to catch up with the primary it's going to require some structural changes on, on access, on transparency, on regulation which, which are coming on the individual deals we, we start to see, we see a lot of continuation vehicles. There was a lot of skepticism a few years ago that funds were using those when they, they couldn't exit something. But I think there are more and more examples now where a GP has really gotten to grips with an asset. They've seen some of the value and they've got real conviction on the value Creation plan going to the next level, that they just, they want to be there for that, that journey. And so they've been using that. And So I think LPs are looking at how much are they rolling forward of their, their own incentives into that to, to check whether it's, it's valid. And I mean it points to a broader question that all these funds are now thinking much more carefully around value creation. If you look back over the last 20 years, a huge amount of the returns were driven by multiple expansion and that game's pretty much gone. Right. And it's across true across all these markets. And so having real conviction on the value creation plan early because you know these markets are competitive, you know, when you acquire something you are willing to pay more than anyone else in the world for that asset. So you better have conviction on how you're going to drive the value creation. And we're seeing that in the primary market. We're seeing it on the secondaries and people taking a much more systematic approach to evaluating that.
- [12:22]
A
Yeah, certainly from the risk insurance side it's interesting on the secondary space it's allowing sort of funds to look at their assets in a much longer time horizon which means they can take a much more sophisticated approach to risk transfer. And so you know, we're seeing much more engagement with the, with the sort of their risk partners in that regard.
- [12:44]
B
Well just on that point that, that'll be interesting to see how the industry evolves and do we move away from just pure sort of closed end funds? We're seeing in some areas with the evergreens. But should that become something more common so that investors can look over that longer time frame and get all the incentives aligned across the different stakeholders?
- [13:05]
A
Yeah, and I think that the time horizon allows them to sort of to be more creative around the portfolio, sort of constructs across common risk. So again, I think the opportunities to sort of create value in other areas as you say, where historically they've sort of looked at the more sort of straightforward financial engineering, there'll be more sort of continued opportunities for value creation just in different areas. So it's going to be fascinating to see how it all plays out. And John, just briefly, Benny mentioned the sort of retailization and greater sort of access to private wealth. How are you sort of seeing that it manifest itself at the moment?
- [13:47]
B
I mean this is a huge prize for the market the way the biggest funds look at this. Right. Given the scale of those assets in the private wealth markets, the limited allocation they currently have to private markets and frankly the Lower fee sensitivity that those investors have versus the traditional institutional ones. And so over the last probably five or six years you've seen a really big shift with a lot of funds focused on how do I go raise from that market. Some of the largest ones spent a couple years building up large teams before they raised a single dollar. But now they're talking about being able to bring in a billion dollars a month. And so that has huge implications then for product design. Right. We're seeing a lot of the innovation around the semi liquids, how you think around the evergreen structure, but also for fees, for risk, for even brand a lot of private equity funds, I mean the key was in the name, they were private. And now when you start going after that market, brand matters and you see this with the big funds. And so a few can go direct and will invest in that brand, which is a very different philosophy from where they've come from. And they'll focus on building out that distribution, but others aren't going to be able to do that. And so I think the role of some of the intermediaries, some of the platforms, what kind of data and information is available, that's a really interesting game that we're in the early stages that's just starting to build out.
- [15:11]
A
Excellent, thanks for that, John. And obviously one of the things we've been sort of talking a lot about is this back to basic value creation piece. But obviously you can't have a podcast at the moment without talking about AI and the impacts that that's going to have. Benny, just sort of from your perspective, when you look at your sort of territory, what are you seeing in terms of the opportunity and both risk associated with AI at the moment?
- [15:39]
C
Yeah, there's a lot of activity obviously currently not only in our underlying portfolio companies and the GPS we work with, but actually also on our side. Right. So many applications are still development phase, but specific use cases can be found in areas also on the secondary side, just like extracting data from quarter reports, bringing it to standardized format to be used as input for our models, or getting quicker insight into comparable price analysis from various databases. So there are really more and more application formats. I mean there are some discussions around and I know that some of our peers actually already have implemented an AI bot as an IC member. Right. Whether voting or not voting. But it's, it's certainly very, very interesting trends that you're seeing here. So yeah, I think at this stage the main common goal is, is really to increase efficiency and, and free up time for our investment st to Focus on more in depth underwriting analysis of our deals. Right. So that, that's really what's AI for at, at the moment. But maybe also important to note that for companies we invest in, AI is really on all agendas. Right. It's not only for IT tech or software companies, it's really across the board industrial consumer services company, healthcare businesses or some other sectors. You'd probably actually not first think of AI, but I guess in many segments really thoughtful adoption of AI will play crucial role actually for companies to defend a certain market position or actually improve a competitive edge in the coming years. So certainly very important value creation measure.
- [17:26]
A
Thanks. And John, obviously it's a critical part of what you're doing now in terms of the work you're engaged with, both at a fund level and also at the portfolio company value creation level. What are you sort of seeing coming through at the moment in terms of things that are really driving from the AI work that's taking place?
- [17:46]
B
I mean, similar to Benny, we're using it a lot ourselves. It's speeding up the work, it's allowing us to go deeper. We see it a lot on the diligent side. Every diligence now that we do has some sort of AI component to it and evaluating how exposed this company is to some of those changes. What can you do, how can you use some of that? So we see it a lot in the diligence, but I'd say the most interesting area is how it's starting to feed through on the value creation planning. And this is still in the early stages. There's a lot of use cases. If you've got call centers or you've got coding, right. Those are pretty clear how you, how you start to roll that out. But people are then beginning to think about some of the changes in the function, some of the customer journeys that can go across that. And I think the holy grail is can you create some repeatable deployment, whether it's ambient AI diagnostics next best action, where you can drive through sort of double digit improvements in ebitda, but then where you can repeat that not just in one case, but almost productize it and take it across your portfolio. And I think that's where a lot of funds are focusing on. It's still in the early stages, but we've started to see huge benefits on individual use cases that are beginning to get that repeatability and beginning to get that productization. I think that could be really exciting for not just the industry, but for all individual companies to start to talk around Some of the positives of AI rather than just sort of some of the fear around what it means for jobs more broadly.
- [19:20]
A
Yeah, no, and certainly from the risk perspective, obviously cyber insurance has come a long way over the Last sort of 15, 20 years and it's sort of looking now sort of at the exposures that AI is driving, both good and bad. And from the insurance market's perspective, it recognizes that it has to respond quickly and be able to sort of add value in those sort of exposures, both as I say, from a value creation perspective and managing any downside risk that's there. So it's certainly an area where we're going to sort of see a lot of continued activity and where the all of the sort of areas that we focus on are going to need to work together across the risk strategy and people sort of aspects. Just slightly sort of moving to another area if I can. One of the sort of topics that we've sort of seen sort of coming through is talk around market consolidation. Benny, what are your sort of thoughts around that as we move forward?
- [20:25]
C
Yeah, I actually really see both consolidation but also fragmentation. Right, but, but the trends toward consolidation has obviously been much more prominent in recent years mainly because I mean in consolidation place we often talk about large scale cover page type sort of transactions. Right. But then also we have entered a cycle where for various private markets applications, size and scale matters. I mean you have mentioned the democratization of private markets and associates requirements to offer more complex semi liquid solutions for those retail investor evergreen structures and so on. It's just like something that alludes better to really the large organizations that actually have the scale and also to really manage those complexities. And that's certainly a driving factor there in the consolidation on this end, on the other hand, and as I mentioned before, right, underlying asset level value creation is still largely to be found in that small to mid cap space generally managed by smaller funds. And therefore the market not only calls for those large scale platforms with broad structuring expertise, but also for those small setups that actually create value on the underlying asset level. And those setups oftentimes emerge as spin outs from those large organizations that may have become too large actually to really move the needle in that underlying small mid cap segment. Right. So finally I think I'd add there with overall growth of the market and ever increasing sophistication of private market investors, new solutions and services will be developed, particularly also on the AI side and really to serve the dynamic market. And that also creates opportunities not only for very large but also for the fresh new and entrepreneurial setup. So I think we really see a little bit of both ends there.
- [22:17]
A
Okay, thanks, Benny. John, what's your view on consolidation? Who will be the winners and losers in this potential process? And how do you see firms either defending or using this as a growth strategy?
- [22:27]
B
I mean, I like how Benny framed it. We see a lot of the similar trends and we're seeing some sort of active consolidation right at the top end where those funds are realizing scale matters and they want to have something to be able to offer to LPs at every point in the cycle. So you were seeing acquisitions of credit funds, of infrastructure, of, of different areas and, and that I expect to, to continue. But you and, and Benny talked around the specialization of some of the funds, which I agreed with. There's also another group of what I'd almost call quasi zombie funds where you had a fund that was successful in the, the past and now, given the fundraising challenges, if they were trying to raise X and they only raised half X, then a lot of the junior talent isn't going to stick around and they'll leave. And a bunch of these funds are at risk then of going down to a skeleton staff. They'll run the fund for another eight years. They'll take fees, but they'll, and they'll, you don't have to worry about them. They'll do just fine. But they probably won't ever raise a new fund. And so you'll get some de facto consolidation as a, as a result of that going on. But I'd say the backdrop against this for all these companies is you've got so many of these changes going on. And in a time of uncertainty, it's never been more important for a fund to really know what it wants to be. What's the differentiation? Who are, in effect, the customers that we're serving? What needs are we meeting for them and why and how are we better than the competition? And your strategy can evolve over time, but you've got to be really clear on what that differentiation is and sort of what you want to be when you grow up. And I think some of the funds are still figuring that out.
- [24:12]
A
Yeah, no, it is. It'll be fascinating to sort of see, as you say, the, you know, if we do get that sort of situation where you have got funds fundamentally sort of in runoff relative to those which are, you know, driving new strategies with clear visions of what their future looks like and being able to attract the capital they need to make that real great. Obviously, we've been focusing on some of the long term sort of issues of the sector. But can I just sort of get your views, starting with you Benny, on some of maybe the short term issues that we should be thinking about?
- [24:47]
C
Yeah, I mean one was just like what John actually referred to, right? I mean some of the zombie funds and actually just a natural selection of the winners. I think that's just part of private markets anyways. Right. And we will obviously see that in challenging times that there will be a lot of movement around there and the organizations and the PE firms and how they set up themselves. I also think that, you know, the successful PE firms, they usually attract the best talent, right. And that again just means that they are flexible to adjust to new trends, capture the benefits relatively quickly. So. So actually I wouldn't be too concerned about, about private equity firms. There is just like this natural selection playing all the time. What I would say for private market investors, I think there are some really key criteria that they really are important for the long term success actually of investing and just like the long term success more generally. So some of those are. I mean while there is a level of convergence between liquid and non liquid investment or investment styles, investors should not forget that underlying assets acquired in private markets are still illiquid. Right. So hence they should plan portfolio construction in line with their really liquidity or liquidity requirements. And I think they should constantly deploy capital over time, don't try to time the market. Some of the key mistakes that we always see, particularly in challenging environments, they should always remain very selective but at the same time not forget to diversify their portfolios. And that's really not so easy with private markets because it's obviously building up over time. So you also need to be careful that you're actually not over diversifying in an overall portfolio context because then you have those zombie positions in your portfolio. So actually that means certain level of sophistication with the investor is required also to actually a bit more actively manage your portfolio. Portfolio construction not only on the buy time, but also actually towards tail end positions of those portfolios. And then I think diversification, obviously I think John quickly alluded to it also across asset classes. Right. So not only private equity, but really also benefiting from secular trends. And you can particularly see on the infrastructure side, on the real estate side, on credit, really diversified portfolio in that regard actually makes long term resilience of investment portfolio just definitely better. And then at the end, and that's probably a little bit biased from my side, I think they should target Considerably high allocation, diversified secondaries and also core investments. I have to say just more direct programs as those investment types just offer strong risk returns, cash flow profiles, provide access to access to trophy assets, can benefit from market disruption and ultimately reduce blind pool risks and associate portfolio construction inefficiencies. Right. So I think we will see more of those. Although always keeping in mind that primary fund investments obviously are sort of like the backbone of the overall industry.
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A
Great, thanks Benny. John, any short term sort of priorities for you?
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B
I mean over the past, just to pick up on Benny's coming, the past 18 months I think we've seen a shift in how a lot of GPs are spending their time. Much more focus around the portfolio and ensuring they have a path to exit on each of the assets. And then on the deal side, I think the last, well, last six years have basically been a reminder that entry price matters and you have to have a clear path on the value creation because the market isn't just going to give you a multiple expansion anymore. And so we are, I think we're basically back to Private Equity 1.0, where the returns are going to come from good old fashioned rolling up your sleeves and driving value in the companies. And so how you think around value creation before you do the deal and then how you drive it becomes more important than ever. And ultimately this becomes a much more of an active than a passive opportunity.
- [29:06]
A
Yeah. And certainly again in the insurance sort of space, we're in a really competitive environment now. So the opportunity for the funds at a sort of macro level in terms of looking across their portfolio of assets has never been greater to capture real genuine sort of savings and really enhance sort of EBITDA and be able to sort of set up portfolio companies for really good exits. So we're seeing a lot more activity by the funds in sort of the utilization of how they approach the insurance market to drive value. So that's really coming through at the short term, at the moment in a very competitive market, which is great. Okay, we're coming to the end of the episode. Can I just, I'll invite you both if I can, just to give one final sort of takeaway. Starting with you, John.
- [29:57]
B
I think we just touched on this, but this is a really exciting time for private markets. They're, they're maturing but I think the, the folks that will outperform are those that really go back to basics, that think around entry price for an asset and think very carefully on how they're going to add value through it. And the ones that can do that well and have a compelling proposition I think are the ones that will excel and make the most of the opportunity.
- [30:24]
A
Brilliant.
- [30:25]
C
Benny could just fully agree with what John just said and would like to thank you for this interesting conversation actually, and then also looking forward to anyone that is actually attending Super Return next week. The market is growing. I think we're expecting somewhat like 10,000 attendants there, but there'll certainly be a lot of fun time and a lot of new insights being shared there as well.
- [30:50]
A
I'm sure both of your sort of sessions at Super Returns will be well attended and hopefully building off the conversation we've had today. It will be an exciting event and it's such a great gathering for the industry. So that's all for this edition of Risk in Context. We hope you've enjoyed our discussion and thank you for listening. You can rate, review and subscribe to Risk in Context on Apple Podcasts or any other app you're using. You can also follow Marsh on LinkedIn or X. In addition to your podcast feed. You can find more episodes of Risk in Context and more insights from Marsh on our website marsh.com until next time. Thanks again for listening.