← The Private Equity Podcast, by Raw Selection
The Private Equity Podcast, by Raw Selection
The Growth of the Private Equity Secondaries Market and What is Coming with Cari Lodge
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- [00:00]
A
Foreign. Welcome back to another episode of the Private Equity podcast by Raw Selection. Joining us today, Carey Lodge, managing director and head of secondaries for CF Private Equity. We're going to deep dive into the secondaries market. What's happened with this absolute astronomical growth, the opportunities that are coming forward for private equity in this space and Kerry's going to demonstrate her absolute passion and love for for this particular space in the second booze market. So let's dive in. Barry, if you can share a brief insight into you, please.
- [00:36]
B
Yeah. Thank you, Alex, and thank you for having me on the private Equity podcast. I'm Carrie Lodge. I head up secondaries at CF Private Equity. I've been investing in secondaries for 25 years. I actually came out of Columbia Business School and joined DLJ Credit Suisse right when they merged and was part of the original strategic partner secondary team. Back in those days, the secondary market was about $2 billion. Today the secondary market just had a record year of $160 billion. So the market has changed dramatically. I'm part of CF private equity, which is part of Common Fund. Common Fund is a nonprofit at the parent level and runs three businesses, a non for profit educational institute, an OCIO business and a private equity business. I sit on the CF Private Equity board, I sit on the CF Private Equity Investment Committee, and I sit on the Common Fund Asset Allocation Committee. On a personal level, I have three kids which are now adults or young adults. My son is 21 and I have two daughters, 18 and 16. And my husband Andy and I are almost empty nesters, although we see the kids a lot.
- [01:38]
A
Thank you very much for that. So what's one mistake that you see private equity firms making and what would you suggest to correct them?
- [01:45]
B
Yeah, I mean, I think being in the secondary market, we see a lot of funds and we see a lot of what goes wrong in the private equity market that makes people want to sell things. But one of the most common mistakes I think PE firms make is holding onto assets too long. And if you look at the average length of a holding period for investments in the private equity market, it's gone from 5.7 years to 6.7 years. So I think the secondary market exists because people want liquidity and we see it all the time. It could be with companies that have gone public and they take too long to get out of the public shares or private companies in their portfolio where they've been maybe an unsolicited offer, that's a good offer, or they run a process and they don't get exactly the price that they want, but pretty close and they really should just take that realization. Passing on a good exit opportunity often just delays the exit. And we've seen that in a case where we've passed on exiting something and the ROI is the same a couple of years later, you don't know what's around the corner. So I mean, if you take the Global Financial Crisis 2007, there were lots of opportunities to exit, but you know, you know, people thought that companies were going to go public and then obviously everything happened and there, you know, it was a delay of about two years before we saw real exit. So I think just taking and capitalizing on exit opportunities is really, really important for private equity managers.
- [03:04]
A
So that's interesting because if we, if I think about the common perspectives of the perception of private equity is that they are in it, they're out of it too quickly. So it's interesting to hear from your perspective of we've seen family office with longer term fund hold, sorry, longer term holds obviously without a fund structure. So if we just dive into a little bit. Why is it that you've seen quite commonly there's a potential for an exit and then two years later there's a similar exit, rather same numbers, same return investment, which could have been done two years earlier. Is that quite common from what you're seeing, from what you just shared?
- [03:41]
B
I would say it's common, but it is a mistake that we see in, in, in funds. Right. We see a winner early in the portfolio that's really, you know, driving returns for a fund, especially a first time fund.
- [03:53]
A
Yeah.
- [03:53]
B
And instead of locking in a good three times, even three and a half times, they think they can get, you know, another turn on the asset or maybe it's a two times return but you know, locking in good early returns. Investors, when they come back to market, you know, when, when a fund tries to raise the next fund, they want to see dpi. Right. So I think there's more of an emphasis on DPI these days than there has been even historically. I think that's why you're seeing a boom in the secondary market too. So you know, investors are looking for roi, IRR and dpi. And so I think it's important to, to make sure that you're factoring all three of those things in.
- [04:30]
A
Excellent, thank you for that. So share with us for those listening that haven't heard any of the other podcast on secondaries, what secondaries is and then if you can give us an insight as to why we've seen such astronomical growth in the private equity secondaries market.
- [04:46]
B
Yeah. So I think, I mean if you look at private equity or in general, most funds are a 10 year life with two one year extensions. You know there is, there is over, I'd say $800 billion of assets in funds that are over 10 years old. So while you may get exits early in a fund life, a lot of these funds stay around a lot longer than they're supposed to. The other thing is that there's a need for liquidity. Right. I mean that's the basic premise of the secondary market. A need for liquidity that could be someone joining the U.S. government. Right. And they no longer allowed to hold certain interests. Right. So it's just a fact that people are going to need liquidity. And so I think the secondary market has moved from a $2 billion market to $160 billion market because there is a need for liquidity. And especially in the current environment where distributions have been scarce or slower than they have been historically, I think you're seeing a real need for increased liquidity. So the secondary market on the LP side, we're buying into a fund that has closed. So we're buying from an original investor in the fund at some point in the fund's life and replacing them as an LP in the fund. And that's the basic premise of an LP secondary. And now you have another segment of the market, I would say a different segment of the market which is GP led solutions. Coming out of the fund restructurings which we saw after the global financial crisis. Fund restructurings were funds that really weren't going to have a follow on fund. They're carry and management fees need to be realigned for the teams that were still present. And it created a structure that has led to the GP led solutions, the single asset, the continuation funds that you're seeing today. Those funds are also solving for those liquidity issue. And I guess there is no real rhyme or reason why a fund should be 10 years into two one year extensions. As you mentioned earlier Alex, endowments and foundations have a perpetual life. They have an infinite life. So you know, I think what the continuation funds do is they add an element of adding liquidity, allowing investors to make a decision on their own liquidity needs as opposed to being forced to stick into a fund for a very, very long time. Secondary is offer investors from an LP perspective. If you're buying, you know, transactions at discounts, you're going to get a reverse J curve right out of the gate. You're going to get a shorter duration, you're going to get, you know, most funds target and historically secondary returns have, have generated strong IRR, strong ROIs. So if you're just talking at a generalist, you know, private equity secondaries fund, you know, the target returns are probably close to second quartile private equity returns with lower risk, you know, highly diversified. So it's a really good risk return for investors and it gives them, you know, a shorter duration, diversification, good exposure to a range of vintage years in this in the private equity market.
- [07:40]
A
Not only am I the host of the private equity podcast, but I'm also the founder and managing partner of Raw Selection. Raw Selection is a private equity specialist executive search firm with two divisions, one that focuses on portfolio C suite executive hires and one that focuses on private equity direct hires a the back office and investment deal professionals to industry. Alongside the podcast, we're passionate about giving back to the industry and giving people information that they can run and utilize. One thing we do regularly every year is we run salary reports on accurate and live data of people that we've interviewed and people that have shared their information with us. So if you're looking to compare your current compensation or your compensation for your next hire, your private equity firm or portfolio company, then please check out our YouTube channel and see the playlist of salary surveys. Is there. So obviously we've seen a surge in this. Is there quite a lot of opportunities? Obviously the three mentions, you know, GP led funds, continuation funds and what kind of traditional secondary taking the LP out. Is there quite a lot of appetite then at those three levels for you guys to, to, to be involved in or is this kind of a, kind of a hard sell type perspective?
- [09:00]
B
Yeah, I mean, I think, I mean you're, you're getting towards the supply of the market and I think the supply of the market just keeps getting greater and greater. I think, you know, it used to be a buy and hold strategy. You'd invest in a private equity fund and you'd hold it till it exited. Now I think there is more portfolio management and that's really what changed the secondary market is investors looking to the secondary market, whether it's a new CIO taking over a portfolio of private equity investments and by the time you get to your third year in as a new CIO, you own that portfolio. So we see new CIOs come in, rebalance the portfolio, get out of some managers that they don't want to be in for the long term, invest and rebalance the portfolio. That's one Example, we see pension funds are big sellers, family offices are sellers. You know, in this market that we're in today, we saw a lot of investors not wanting to miss vintage years. So if you didn't have the distributions to make new commitments, maybe just par down a couple of your commitments. So Maybe you committed 20 million to a fund and maybe it should be 10 million or maybe you committed 100 million and it should be 50 million, depending on the size. So we saw a lot of younger funds being sold in 2023, 2024 as investors, you know, didn't have the liquidity they were seeking, but still wanted to stay with the best managers. It was also a great opportunity for primary investors to get into managers that maybe in other circumstances would be oversubscribed and they couldn't get into. So I think the smart investors in private equity were utilizing the secondary market to make tactical decisions on their private equity portfolios.
- [10:35]
A
Interesting. What are you seeing from so talked about what's happened? What are you seeing as the, as the future? Obviously I'm going to guess growth. But what's your perception of what is happening or, sorry, what is going to happen from a secondary perspective?
- [10:51]
B
Yeah, I mean, I think this year 160 billion was like a great year. I think that, you know, we think that there's about 200 to, let's call it 220 of dry powder in the secondary market. It's expected that that will all get utilized this year. That we will see a market of 200 to 220 in the secondary market. I mean, the market's really constrained by being under capitalized and under resourced. So I think there's room for tremendous growth in the secondary market. If you look at overall private equity, I think it grew at like 14%. Secondaries grew at 16%. We're still just keeping up with the growth in the market. So there's 10 to 11 trillion dollars of private equity assets out there. And the secondary market at 160 billion is tiny. Right. So there's still massive room for growth, massive room for a more liquid private equity market. And I think, you know, the innovation, the GP LED transactions, the single asset continuation funds, the LP transactions, I just think there's a wide, you know, we're seeing an increase in credit secondaries and infrastructure secondaries. So you're seeing also real estate secondaries. I mean, there's a. The secondary market is becoming broader and it's all a derivative of the primary market. So the more capital that's raised in the primary market, the Bigger the, the prospects for the secondary market. But this, this market surprisingly is only 160 billion. I would have said it would be, you know, 200, 250 by now. It looks like we're now getting towards that path with next year hopefully being 200 to 220. But there's tremendous room for growth. I mean it's a very, very small component of the market that trades.
- [12:26]
A
What, what do you think's the constraint on the market currently? Is it capital? Is it awareness? Where do you see the secondary markets? What's holding it back from being at the level that you think it'll get to this year that you think it should be already be at?
- [12:39]
B
Yeah, so it's capital. I mean it's capital in terms of currency, right? Dollars, euros, whatever the currency be funds being able to be raised. So there is a constraint on capital, but there's also a constraint on human capital. Right. People in the market, right. There's only so many law firms to process these transactions. There's only so many groups to underwrite these transactions. So I think it's a combination of currency capital and human capital. So you know, it's an under resourced industry. You know, it was a very, very inefficient industry. I think we're now more efficient. I think people have heard of secondaries. There's a lot more, you know, people are coming out of college knowing what secondaries are, right? Which is a big change from or taking jobs in secondaries, right. I mean back in my day you sort of fell into secondaries, right? Like I was, I was an investment banker, I was a generalist investment banker and worked in the secondaries program. So when it was originating, I mean back then information was scarce. I think GPS have gotten much, much more transparent in terms of what they're providing in their quarterly reports. I think with the GP LED transactions, I mean the GPS are now embracing secondaries, right? This is no longer why would someone want to get out of my fund? People aren't taking it personally anymore. This is just a natural evolution of liquidity. I mean, no joke, people used to hang up the phone on us. We'd call and we'd say we're going to buy X Y on. And they'd hang up the phone and we'd be like. And it could take us like two or three calls before we were like, what do we do? They keep hanging over the phone on us. But it's just an evolution that this is good for everybody. Liquidity is good for the private equity market, right? It provides investors more opportunity, more choices. The continuation funds are good because it's another option for you. You can get liquidity or you can stay in. It gives you, you know, just more flexibility in your portfolio, which I think is great for the private equity market.
- [14:34]
A
Yeah, absolutely. The. So you mentioned falling into the secondaries market. You kind of explain. I can see a lot of similarities between the recruitment industry. People kind of didn't previously desire to be in there, just ended up being in there. And I've had a few, a few private equity funds hang up on me as well. So we've got something in common, certainly from that perspective. But what, what is it that's. That's maybe you falling into it, but what is. It's kept you in it and what is it made you fall in love with the second space?
- [15:04]
B
I mean. Yeah, I mean, I think the secondary industry is the best. It's just so exciting. It changes every day right there. New entrants, whether it's now we have 40 ACT funds. There's, there's the continuation funds, right. Those didn't, weren't here. It's a constantly changing and evolving market. We get to see the entire private equity universe. Right. So we're in, you know, 1200 funds. So we, we have all this knowledge about what people are doing in private equity. You know, we can go to all these annual meetings. Annual meetings. You hear, you know, I mean I've heard most presidents speak at. I mean it's just, I mean it's an incredible industry to be in. I work with an incredible team of great people. Know we have a lot of young analysts who are just enthusiastic out of college because a lot of our underwriting is that bottoms up analysis. Going through each of these portfolios company by company, revaluing each of the companies in a portfolio. So there's just so much energy around the secondary market and it's a really, really nice group of people. So we're all competitors, but we're all like really, really friendly with each other. So it's just a very collaborative, wonderful industry to be in. And it's exciting because you're constantly learning, constantly changing. I mean, I can't think of a better industry to be in.
- [16:23]
A
Appreciate. That's quite the sell for secondaries. Not only am I the host of the private equity podcast, I'm also the founder and managing partner of Raw Selection. Raw Selection's an executive search firm working exclusively within the private equity industry, supporting the portfolio companies and the private equity firms within. Securing exceptional talent with our motto of De Risking Executive Search. You, you have quite a unique position where private equity is a real closed door in the most part, one of the reasons why we set up this podcast. But you're looking at lots of different private equity firms, you're looking at lots of different portfolio companies and you get a real kind of insight of things. Pretty sure that'll be done a lot at the analyst level and obviously bring certain data. But I suppose as you review those things and you give some consideration to it, what are you seeing as trends currently? What's kind of changing? What's surprising you at the PE level or the portfolio level? That's going. That's quite interesting.
- [17:27]
B
Yeah. Big changes are interest rates are a lot higher than they were. We no longer have a low interest rate environment. We have a higher interest rate environment. So you know how, how companies are held, what multiples are held at. Right. So valuations. Right. You have to be pierced through and, and, and make sure you're getting the companies at the right valuations. Right. And so I think those are, those are two trends. I mean, I think alignment is key across the private equity industry. So I think, you know, what we're always looking for is the right alignment. Right. How much did the GPS commit to the funds? How much are they in the carry? Are they out of the carry? Do they have another follow on fund? You know, what are they incentivized to do with these companies?
- [18:08]
A
Okay. And from a seller's perspective, you spoke about, you know, back in, you know, previously being hung up on, and now the outreach is a little bit warmer, which I think is fascinating. What are you seeing in terms of the seller's market? Why are sellers selling? And do you see kind of supply continuing to increase, which I guess you obviously do.
- [18:30]
B
Yeah. I mean, there's so many reasons for sellers to supply, you know, to sell. I mean, if you think about each LP, there's probably over 45,000 different funds out there. Right. I mean, and some of those are not. That's not fun families, but individual funds. Right. So each LP has a unique portfolio and they have unique needs. Right. You know, a college or an endowment may need money for a special project on campus. A new CIO may come in and want to change their portfolio. A fund of funds or a secondary fund like, like us, you know, gets to the end of their life. And now you have a lot of LPs and very small NAVs across those LPs, so it makes sense to wind down those funds, you know, and, and for a new secondary Buyer, it's one LP investing in those funds, right. And they have a different duration. So those are all good reasons. You know, pension plans, you know, sometimes, you know, they, they, they, they're periods of time when they're overallocated. The denominator effect when the public markets know, dropped and, and the private equity portfolio became outsized. So rebalancing their portfolio, you know, so generally it is a liquidity need, a portfolio management decision. And I think people are becoming more active in that portfolio management because the market is more robust than it was historically. Secondary is. Last year, I mean it was, it was a low distribution year. But if you look at the statistics, you know, 2023, there was about a $750 billion of, of liquidity in the market through traditional methods. The secondary market was 112additional billion on top of that. But this year with 161 billion, there was about $900 billion of exits in the private equity market. So the secondary market is adding about 15% of liquidity to the market. So if we're adding 15 to 20% liquidity to a market, that's actually becoming significant. And that's why people are beginning to notice the secondary market. Right. When we're a $2 billion market, a $10 billion market, we're sort of well below the radar, but we're no longer below the radar in the way that we used to be. And I think prudent managers and LPs are saying, Wow, I can really utilize this market to really figure out what I want to do with my portfolio.
- [20:43]
A
Another Mystic Meg type or crystal ball type question here. But do you think that how. So how tied to fluctuations with regards to markets is the secondary space? Because we've seen a depression in private equity over the last two years. And I was just looking at some, some certain markets always say which one, but certain market which was literally at 10% from an M&A activity for the last two years, which I was absolutely shocked at. Do you a bit like. We try and tie accurately to be fair, but we try and tie everything to interest rates. So private equity seeing a depression because of interest rates. Will you follow the private equity ups and downs or will secondaries either be or become or is its own kind of beast from there?
- [21:32]
B
Yeah. So it's so interesting and you talk about why secondaries is a good place to be an investor. So we really benefit from all markets. So, you know, you do get sellers in a market looking for liquidity like today. So they're coming to the secondary market. Looking like you get markets in an up market, we're able to pay pretty good pricing because, you know, navs are going up and distributions are coming out and that plays well into the secondary market. And that's, I mean, so we do really well in up markets. When everything's going great, we do well too in down markets. You know, know we are able to continue to invest and participate and provide liquidity to the market. So it's really a, a, a good place to invest across cycles. I think that people always thought of as, you know, a distressed play. I don't think it's ever really been a distress play. I think it's been a, a need for liquidity. Now obviously when there is distress, people need liquidity, right? So, but it's really, you know, you know, back in the early days it was the bank selling, right. Because they, their financial sponsor groups had made these commitments to private equity and then they really didn't have anything to do with like the performance wasn't really related to the performance of the team on a day to day basis. Right. It was an investment. So they, they utilize the secondary market to get out of those. You know, we're seeing, you know, now we see, you know, people utilizing the secondary market, as I said, for portfolio management. But I think it's, it's a, it's a great place to invest across cycles. We're obviously not immune to cycles, right. So if 2021 was a high vintage year, it's not going to be the best vintage year for secondaries, but we're still probably doing better relative to the rest of the market.
- [23:16]
A
Makes sense. Thank you for that and there's some detailed questions there, but appreciate you giving the context around it. So what are your influences? What do you read, what do you watch, what do you listen to? Do you recommend that others check out, please?
- [23:29]
B
Yeah, so I mean I do read secondary investors, private equity analysts. I read all the news every day on the various news outlets. I was listening to one of your other podcasts and they brought up the Economist. The Economist was one of my favorite. Pretty nerdy in college, but I used to have a subscription in college to the Economist. I think it's a great publication. And then just picking up a book here and there. Now I'm reading Steve Schwarzman's biography, what It Takes. It's just constantly educating yourself, going to lots of conferences. I do attend a lot of conferences. I speak at a lot of conferences. I attend, attend them. Always interesting to hear, you know, my peers, perspectives, others in the Industry, you know, listening to private equity podcast. Right. Everything, just, just keeping yourself knowledgeable and continuously reading and learning is great.
- [24:19]
A
Yeah, I've read whatever it takes and I think it's phenomenal. As you kind of look and go what a beast that business is now. But also how much, you know, it was on a knife edge of whether it was going to happen and then trying to win investors and think it was them stood out in the side of the road getting wet and all that kind of stuff. So you get all that kind of context and to also be, to be able to see that happen in a, in a life cycle, it's not like it was a business that was taken on from someone else. The, these organizations or private equity firms have been taken turns in people's life cycles and you know, it's not like a, I don't know, a GE where we've seen loads and loads of turns of that organization. But what's been built I think is, it's kind of gives you a bit of context. You know, these are real people and they've just built businesses and you know, they've been stood out in the rain and getting soaked and trying to pitch for things on the back of fag packets type scenarios. I think it's, it's well worth a, well worth a read. How does anybody reach out to you if they wish to do so? Please.
- [25:19]
B
Yeah, LinkedIn is great. I'm on LinkedIn, so LinkedIn is a wonderful way to reach out.
- [25:23]
A
Perfect. Well, thank you very much coming onto the podcast. Appreciate your insights, appreciate your absolute passion and love for the secondaries market and I'm glad that you found that, if not by chance with regards to your career, but absolutely admire your passion into that. But thank you very much for sharing everything you have and gives an insight into what's happening, what's happened within the secondary space.
- [25:45]
B
Great, thanks, Alex, and thank you very much.
- [25:47]
A
Excellent. And thank you very much for everybody for tuning in yet again for the private equity podcast. If you haven't done so already, please do hit subscribe. You'll be notified of the next podcast that comes out every single week, but till the next time, keep smashing it and thank you very much for listening.