Despite private equity managers raising a record USD453 billion in 2017, it is estimated that the amount of dry powder has risen to USD1.3 trillion. Whilst PE managers search for the best investments, this dry powder sits idle, to the detriment of investors. This is pushing large institutions to increasingly go down the direct investment path, with blue chip names like BlackRock aiming to commit USD10 billion to direct investments under the moniker, BlackRock Long-Term Private Capital.
Many other large institutions, with Canadian pension plans leading the way, are building out their investment portfolios beyond merely holding LP stakes in investment funds.
Against this backdrop, Credit Suisse Asset Management’s Private Funds Group recently established its Directs & Co-Investments Group, to complement PFG’s existing primary and secondary advisory business.
The Directs & Co-Investments Group will advise and assist PFG clients in the structuring and placement of private direct investments into the institutional investor market. The initiative is led by Credit Suisse veteran Managing Director Paul Van Hook, with Imran Hameed as a Director in the Directs & Co-Investments Group; Hameed joined from Mercury Capital Advisors, a New York-based private equity placement firm, where he spent the past five years as a key member of the transaction team placing institutional capital for clients.
“Since its inception, Credit Suisse’s Private Fund Group has sought to provide Limited Partners and General Partners with a diversified set of private placement services and secondary solutions,” says Kevin Naughton, Co-Head of the Private Fund Group at Credit Suisse Asset Management. “Direct investing has become an increasingly significant part of investors’ approach, as they seek direct access to assets and portfolios to enhance returns and complement their existing investment strategies.”
Two years ago, the PFG team began to look at the business with a renewed strategic mindset.
“Investors were looking more toward the direct investing and co-investment space as a creative portion of their portfolios. We responded accordingly,” adds Naughton. He says that unlike a lot of other secondary advisory businesses, which focus on whole portfolio sales, GP positions etc., “our approach has been what I describe as a strategic liquidity option for both GPs and LPs. When we looked at the growing direct investment demand and what we were doing in our secondary advisory business, we started to see the intersection of the two businesses.”
As one of the largest, most cohesive and experienced global private placement and secondary solutions teams in the industry, PFG has raised over USD500 billion for 366 funds since 1994.
Since 2010, it has completed 26 transactions in the Directs & Co-Investments space across USD4.2 billion of total interests transacted upon.
Large Asian SWFs and other institutional investors have historically tended to focus on the direct investing space and represent an important regional market for PFG to tap in to. At some point in time, Naughton hopes the integration of the Directs & Co-Investments Group “with what we are doing on the private banking side in Asia could be very accretive for both of us”.
The way the PFG team sources all of its deals is based on using an integrated model.
“We believe our structure gives us a unique sourcing engine. We have 21 distribution professionals speaking with investors all over the globe who are working to understand portfolio priorities and areas of focus. In addition, our 35 project management professionals are constantly interfacing with our GP clients to consult on portfolio construction and investment opportunities,” explains Naughton.
Within the primary fund business, Credit Suisse has built a market leading reputation; something it hopes to achieve for the direct and co-investing platform. The modus operandi of the bank is to create what Naughton refers to as “tangential businesses”, whether that’s in the secondary markets from a liquidity standpoint or the direct investing business from a deal flow perspective.
“The direct business is a compliment to what we do. It is a business we think is scalable and can grow over time but it won’t displace our core primary funds business,” he says. “Ultimately, what we are trying to do is continue to be relevant to the LP universe from a portfolio construction standpoint.
“When I first got into the business in 1999 there was less fluid and active portfolio management on the part of the LPs. Back then, a secondary trade was viewed as a last resort option and was only done because you needed liquidity to deal with other problems.”
Now, the PE secondary market has become a meaningful part of active portfolio management and Naughton is confident that the same thing is going to happen with the direct investing market.
“We think it will allow our LP clients, as they look at their portfolios, to either put more absolute dollars with managers they like in co-investment opportunities, or more absolute dollars directly in sub-sectors they think are attractive from a risk-adjusted return standpoint.”
What the PFG team, and others in the marketplace, has to try to resolve is the extent to which large institutional investors choose to build their own internal investment teams.
“That’s what we are trying to figure: will pension plans outsource it to the largest asset managers or will they develop their own internal investment teams? The Canadians have always had this direct investing bent but you see it now in the State of Virginia, who has someone responsible for their co-investment portfolio. By contrast, the State of New Jersey has outsourced that function for years,” comments Naughton.
Aside from direct and co-investing trends, the fact that investors are more actively trading LP positions in various PE funds has led to a more buoyant secondary market. The stigma of divesting has largely been removed. Both managers and investors accept that there are far more dynamic forces at work and that the concept of forced selling, while still applicable on occasion, no longer dominates the narrative.
Years back, there was more of a siloed approach and less thoughtful consideration of one’s portfolio and risk-adjusted returns, and what other parts within the illiquid alternative asset class investors should be exploring to meet their needs. A lot of this came to a head in 2010.
Prior to this, everything clipped along in a normalized fashion. Then in 2010, there was a recognition that active portfolio management was necessary. The secondary market subsequently became a more strategic consideration for LPs. The secondary buyer is no longer just secondary funds. Primary LPs are also behind secondary positions.
“The evolution has really picked up steam over the last couple of years with more focus on direct investing and co-investing, so it’s actually a really interesting time to be in this space. We believe the allocations to these assets are going to continue to grow.
“The LPs I speak to on a regular basis are concerned that pricing is a bit heavy. They are worried about ensuring private equity returns continue to outperform other indices and at the end of the day, with so much dry powder in the marketplace and prices rising, making the right allocations to GPs is critical.”
“LPs recognise that if they can pick one or two assets in a PE fund that do well, that can help drive the overall return. That has a lot to do with the direct and co-investment trend we are seeing today,” concludes Naughton.
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