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Welcome to the EY Next Wave Private Equity podcast where industry leaders come together to discuss emerging opportunities and industry trends shaping the global private equity landscape. 

Mark Benedetti

The prediction is that this market is going to be 200, 300 or even up to 500 billion in some estimates in the next 5 to 10 years. 

Bridget Walsh

That was Mark Benedetti, the Co-head of Ardian US. I’m Bridget Walsh, the Global lead of EY’s Private Equity. In this episode Mark will be sharing his insights into the role of secondaries in the private equity market.

Mark, welcome to the podcast.

Benedetti

Thank you. Thank you for having me.

Walsh

Mark the secondaries market has seen huge growth in recent years. In your mind what has driven that growth?

Benedetti

I really think it’s two factors. First there are secular trends that are moving it up and there are also some things that are quite topical at the moment. So, if I go on the secular side of things, the first answer to the question is, look private equity is no longer an alternative asset class. It’s everywhere, it’s grown. If you look at the total NEV and AUM of private equity in total we are talking about trillions of dollars compared to you know low billions if you go back 25 years ago, and so any big market needs a secondary market to function properly, and more importantly I think if you went back 10 or 15 years, you know ancient history, the secondary market was really a tool for groups who are the liquidity constraint. So, somebody who needed cash for whatever reason, and it was almost seen as a distressed seller’s type of market, and it totally changed. Where now groups use the secondary market to actively manage their portfolio. So, what does that mean? If you are a pension planner or a sovereign wealth fund, and you are too exposed to the middle market and you want to do more in large cap, maybe you sell some middle market funds and you go more into large cap. Or you are too exposed to US and you want to go more into Europe and you sell one to go into the other. Or you are too exposed to too many groups who are in the same type of sector. So you sell down one or two of them and you consolidate your investments into another.

So, all the same reasons that you would sell your stock portfolio, your bond portfolio, groups have now been accustomed to using the secondary market to actively manage their portfolios, and that is a phenomenon that we really started seeing in earnest starting in about 2014. Well fast forward to today we are in a market that is now doing $100 to $200 billion per year of volume. So a lot of that is just groups who are used to this, this liquidity and who want to use it. The second topical reason is really a question of what’s happened with private equity in the last few years versus the public market. So, I’ll give you a good example. I was talking with a big North American pension plan, they are a group who is relatively new to private equity. They’ve really ramped up in the last 10 years and their private equity book did great. It returned 25% per year over the last three years, but a largely unrealised gain and then the public markets have done what we have all seen. So, overnight they went from being within their target allocation to being massively over allocated, and that’s what we call the denominator effect, and so that is adding to this what we think is $150 to $200 billion steady stayed volume market, with even more groups who need to sell because they’ve over allocated and you need to get that allocation down.

Walsh

Yeah, I think that denominator effect is really prevalent at the moment. Ardian have been hugely successful. You’ve done some of the biggest deals that have ever been done in this market, what’s contributed to your success? Has it moved in tandem with market or to achieve those kind of returns presumably you’ve done something a little bit ahead of the market?

Benedetti

We have always been the largest secondary fund in the market. If we go back to our fund 4 all the way through the fund 9 that were in the market now, we’ve always been the biggest provider of liquidity in the secondaries market. And that is a judgement call we made because we saw that this growth in volume was gonna keep going, and if you look at a big pension plan or a big sovereign wall fund who wants to do a secondary deal to manage their portfolio, you know if you’re managing $15 or $20 billion of private equity you’re not gonna do $100 million deal. That’s not gonna help you with any of your goals. What’s gonna help you is a deal that’s $1 billion, $2 billion. So what we’ve really focused on is becoming a solutions provider to those large groups who want to do something quick, who want to do something easy, work with somebody who can under ride the whole transaction, work with somebody who is already an existing investor in most of their portfolio. You know we’re an existing investor in 1,600 funds around the world. So, we have a huge database. We have the biggest team in secondaries in the market, and when you put all those things together it just means we’re a very quick easy turn key solution to a seller who wants to do something in size and relatively quickly and because of that you know we can command some pricing, command some portfolio construction and that’s all to the benefit of our investors. So, I think our success has been of course, we’re one of the pioneers in the secondary market. We’re one of the first groups to have a secondary fund, but we’ve grown with the market and we’ve tried to stay a large provider of liquidity in this market.

Walsh

You’ve done fantastically well. You should be really proud Mark, and Mark you touched on volatility, you touched on the denominator effect. How cyclical is this industry or are you able to make returns both sides of the cycle? 

Benedetti

So, yes we get questions about groups who will sometimes think you know with the mindset of 10 years ago that this is still a market where distress drives volume. It’s actually the reverse. In periods of great distress there is now a lot of secondary volume. Actually things freeze up. If you go back to March of 2009 everyone was expecting a big wave of secondaries but that wave didn’t come until H2 2010 and then I t came and it was a big wave of secondary deals, but in the peak volatility when things are really cycling downwards in the public markets groups aren’t selling. Once the market got a little bit less volatile and things settled down then groups came back to the market and started selling in huge volumes starting in 2010. If you go to COVID same difference. You know if I to March 2020, March 2020 that whole first half of the year there was very, very little secondary volume, but then the second half of the year it picked up as things kinda settled down. What is very interesting is if you try to make a prediction for the secondary market volume for 5 years, 10 years, 15 years and you do it any which way. So, if you took a line and drew it just on secondary volume or if you just take the primary fund raising and added that to the NEV that’s been growing in private equity in general, and then took a percentage that typically trades every year, or if you go any other metric the predictions is that this market is gonna be $200, $300 or even up $500 billion in some estimates in the next 5 to 10 years. 

Walsh

So, a phenomenal space to be in, you know you grown and then taken great advantage of this but it sounds like a lot more to go for as well as we look to the future Mark?

Benedetti

And I guess that 1,600 funds that you are invested in kinda creates that moat, you know around you really and I suppose that takes me onto due diligence. You obviously have a lot of info, you’ve got access to it at your fingertips, but again in a market like this you know some funds are going to do better than others. So, is there a particular focus around your sourcing and diligence at the moment?

Yes absolutely. So, you’re absolutely right. Not all NEV is created equal. So, if you look through the NEV of a given fund there are some groups who value their assets quite conservatively. Some who value them more aggressively and then there’s also a timing aspect where if you know, let’s say a big fund is about to come to market to try and sell one of their top assets, it could be an interesting time to buy that fund now, in advance of a liquidity event coming in 6 to 12 months let’s say, and to your point you need to have the information but not just be able to access it. You have to treat the information, you have to use it, and one thing that we did 15 years ago was we created a database and our investment team is mining this database where we are re-underwriting all the private assets for hundreds of private equity funds for every company within those funds, every quarter whether or not it’s for sale, and what we find is over time you really get a sense for the managers that over promise and under deliver or vice versa for those groups who over value or under value their assets and then for the assets that just perform over time. Asset selection is the biggest part of our return contributor. If I give you one data point and we get a question all the time from our investors and from the market to say, hey are private equity assets over valued because I saw public market go down by 20 or 30% but the private equity assets have been relatively stable. Is that because you’re just not taking the pain are they over valued?

Well I’ll give you one data point. For all the exits we had in our portfolio last year, so 2022, the average exist that came out of the portfolio was 40% higher than the NEV as marked by that general partner one quarter before. So that’s the beauty of asset selection and that’s the benefit of having this database being able to mine it and then entering it at the right time.

Walsh

I love that phrase, not all NEV is created equally. I think I’ll end up using that Mark. You took me on and you pre-empted my next question around evaluations, you know there’s been a lot of press as we all know, public markets valuations done, you know are private equity marking to market correctly but the 40% statistic you just shared, it kind of implies GPs are quite conservative. Just can I explore that a little bit more?

Benedetti

I think it’s really manager by manager and you can’t say all of them follow the same pattern. In particular profitable assets with you know leading business models that are number one in their field, number two in their field, there’s still a bid for those assets even if the debt markets are more complicated, a lot of private equity funds out there have raised money, they want to put that money to work. What do they want to buy in today’s market which is relatively uncertain? They want to buy market leading companies okay who have grown, who have shown that they performed through different downturns etc. So, when those come up for sale they usually get bid at a premium and that’s when you’re getting that exit which is 40% above the NEV. But those are for the market leading companies and I think that’s gonna continue. If you have a poor quality asset something that hasn’t performed well you know there may not be a bid for that asset for sometime, and that’s not surprising. On the flip side unprofitable assets, that’s something that we’re much more cautious on. If you have an unprofitable asset and it’s losing money well you know you’re gonna have to raise money at some point soon. There’s never a good time in the market to be forced to raise money when things are a little bit volatile and so you’re seeing some capital funds or venture capital assets rather or some growth equity assets that are unprofitable having to go back to market and taking down rounds. That’s where things have been very hot for the last five years. They’re marked off revenue multiple sometimes, very, very high valuations. In that case there I think you might see some pain in the valuations in the next 6 to 12 months. But for typical growing bio assets in developed markets so far it’s been very stable and we’ve been surprised on the upside for good quality.

Walsh

That’s great context Mark and I think you’re really talking about relativity within that and that’s great perspective as well. Again when we come back to the press, when it comes to the secondaries market again a lot of focus around the GP led market, you at Ardian have done a lot in the LP space? Maybe just elaborate a little bit on the differences and help us put them into perspective.

Benedetti

The secondary markets started off 20 years ago with LP portfolio secondaries. So, very classic secondary deal, a group has invested in Black Stone, Carlisle etc, big managers and for whatever reason they wanted to sell and someone would come and buy their portfolio and step into their shoes as a limited partner into those funds. About 10 years ago a new technology popped up called GP led secondary deals where at first it was really GPs who didn’t perform very well, who maybe had an orphaned one or two or three assets left in an old fund that maybe didn’t make it or those assets under performed and they wanted another kick at the can. So they invited secondary players to come and say hey you buy these assets, give liquidity to my investors who have been sitting around for 12 or 13 years and who want out, and give me this manager a chance to hold them for three or four more years and see what can do. That was version 1.0.

Version 2.0 was a little bit similar to that but it really started transitioning away from these kind of poor quality funds or managers to really performing managers who said wait, if a group can do that for a poor quality asset maybe I can do it for a good quality asset where I just think there’s more upside and I just want more time. Well the existing investors who invest in that same fund 12 years ago might say, you know what I’m happy with your returns, declare a victory, sell these assets and move on, well that’s where the secondary player comes in and offers liquidity to those groups who want out, and go along for the ride for the new version of these, or the new holding period for these assets for three or four more years. And that has unlocked a huge wave of deal flow which was about 40 or 50 billion depending on how you count it last year or last couple of years, and it is I think only gonna grow from here, because groups who say I have got this star asset and I think there’s more upside to be had and I don’t want to sell it just yet, this is a great way for them for to continue with that asset and also it’s a less risky bet than buying a new company it’s an existing management team they’ve worked with before. The trick is doing so at the right balance between price for the seller and buyer, and what we’ve found is that the LP market today is trading at a double digit discount. So, we’re doing deals at 15 to 20% discount, those are very interesting prices for a buyer and that’s just because you know we think that it is $200 billion of pent up supply that has not been able to transact because there’s not enough buyers to do it, and so buyers can command some very good pricing. But I think more will clear once we get pricing within a 10% discount. Call it 0 to 5% discount there’ll be a huge wave of these deals that have been sitting on the side-lines waiting to get done.

Walsh

What a fascinating market to be in Mark. $200 billion of pent up supply, huge barriers to entry given the institutional knowledge you have, I can see your excitement around this but when you look out 3 or 5 years will the top 9 or 10 players in the market still be relatively the same? What’s your prediction here?

Benedetti

My prediction is largely yes. I think there’s gonna be more and more specialisations. There are buyers who have really focused on different things. There are groups who now only do GP led deals. There are groups who do only single asset GP led deals meaning not two or three or four companies but only doing GP led transactions when there’s one company for sale. There are groups who are focused on tail end secondaries meaning really old portfolios where it’s more of a beta new play, you try to get a big discount at entry. There are groups like us who focus on the $1.5 to $2 billion LP portfolio in US and Europe. There are Asia only secondaries. There’s infra secondaries. There’s real estate secondaries. There are even groups who focus on buying pieces of other secondary funds. So, there’s a lot specialisation which is not uncommon for a market that is maturing and if I look forward 5 or 10 years I think it’ll only be more specialisation.

Walsh

Mark that accords with the private equity industry over all as we see you know abundance of multi asset managers and then within that the specialisation, the niches, the credit funds, distressed funds, so you can just see how that evolution happens in line with the wider private equity market.

Benedetti

You know one thing that I think is interesting is if I look back 5 years ago and we were talking about what the next 5 years can be in secondaries we had done a deal that was a $2.5 billion deal. At that time it was the largest ever transaction done and someone asked me at that time, well what’s gonna be the next largest deal that will ever be done and I had joked that there might be a $5 billion deal in the next couple of years, and sure enough three years ago we did a $5 billion secondary deal. So, my outsize projection for the next 5 years is who knows, maybe we’ll do a $10 billion secondary deal one year.

Walsh

Mark thank you so much for joining us today. What a great insightful explanation of the secondary market.

Benedetti

Thank you for having me.

Walsh

That’s it from today’s podcast. Please do be sure to subscribe for more great insights from the PE industries top professionals and  luminaries, From me Bridget Walsh and Mark Benedetti goodbye.

Thanks for joining the EY Next Wave Private Equity podcast. For more insights and perspectives visit EY.com/private equity. 

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