CS’s McDonald: Get LPs on board before launching fund revamp

Credit Suisse appointed Mark McDonald head of the global secondary advisory team in January. McDonald will work with Chris Areson and Gordon Appell, who will co-head the Americas business, and Jonathan Abecassis, who will be responsible for EMEA and Asia. McDonald succeeds Mike Custar.

McDonald chatted with Buyouts recently about his outlook for the secondary market this year:

How has the industry evolved?

Secondary buyers have tooled up and increased and widened their skill sets over the last five years significantly. Gone are the days when someone from a PE fund or investment bank moves over to a secondary fund and starts pricing interests in megafunds.

Look at the larger, more established secondary funds today. You have people from the industry, from consulting, from credit backgrounds, infrastructure backgrounds, people with direct or co-investing specialization.

That skill set enabled large amounts of capital raised in the secondary space in the last few years for what I call two strands of capital in the secondary market. One is focused mainly on LP interests, which has been the market over the last 20 years. That continues to grow with more competition in that space than there was. [Second is the] entrepreneurial side, spinouts to structured transactions to widening the types of deals on GP-led processes like restructurings, tenders, or mix of both … and across asset classes, venture hedge funds, RE. … We’re working on a couple situations in the private debt space as well.

Is there too much secondary dry powder? How will all the capital raised for secondaries find investments?

I saw something published recently … where in terms of the private fund or PE assets in the world today it totals around $2.5 trillion of assets. That’s a huge number. The secondary market on that is a drop in the ocean. In most mature markets, the secondary market is bigger than the primary market. I’m not saying the secondary market will be bigger than $2.5 trillion, but [look at] the way secondaries is going: Five years ago secondaries was still a cottage industry, LPs weren’t really using secondary unless they needed liquidity. Now it’s a more normal course of doing business. We see large pension funds use the secondary market as repeat sellers. A sovereign wealth fund sells $2 billion of assets 18 months ago and no one really blinked.

The market is pretty active, we think between $35 billion and $40 billion for 2017 should be achievable, notwithstanding exogenous factors and political instability. The secondary market has seen these cycles before and will be robust.

A few GP-led processes have fallen flat over the past year. How do you get comfortable with GP-led processes?

The first questions we ask: What do the assets look like? Are they assets of quality? And is the GP credible, or is there a new GP in place in a non-hostile situation? [And] do the LPs in the fund support the transaction? Are at least a portion of them interested in generating liquidity? When we get in situations where all those boxes are not ticked, we end up not taking it.

There are situations we’ve seen fail at the final hurdle. … We’ve declined many of those because there’s lots of noise around them. … [Situations like this] reemphasize the necessity to scrub the deal, do due diligence up front, and have LPAC approval up front before you launch. We don’t launch a process until we’ve spoken to key investors. In the old days, 2012 to 2014, Tier 3 or 4 GPs were getting with advisers to make a quick buck, having not thoroughly consulted with the LP base. … That’s not helpful.

If you take a step back, some investors are trimming their portfolio anyway. A lot of pensions have 150 GP relationships with three or four people managing the portfolio and they’re being instructed to make larger commitments to fewer managers. If they have the option to generate liquidity through a market-tested process … we’ve had a lot of success in helping LPs just get out.

LPs very much appreciate the fact they’re being consulted before a process is launched. Often we’ll come with a proposed process. … We ask for feedback, and certain times LPs will say yes, and other times they’ll say, actually we think that could be potentially a conflict further down the line. We build that feedback into the process to accommodate all LPs. It makes for a much smoother and less confrontational process.

What kind of regulatory scrutiny are you seeing in the secondary market, especially around restructurings?

You’ve had some processes which have been run not in the best interest of all stakeholders and the SEC has taken some attention.

The market has gotten better at addressing perceived conflicts. At the end of the day, if you get the process right, you’re providing a service to LPs. [These processes] are more often providing a status-quo option and option but not obligation to sell out of that fund.

I don’t think there’s enough evidence to support an action there, but the SEC is rightly doing its job of saying well, look, these practices seem on the face of it, they could have some conflicts, we need to understand more.

What’s your outlook for secondaries this year?

We probably see the market four to six months in advance just by people talking to us about what they want to do during the course of the year. We think that pension funds will be continued sellers. Large pension programs still have a lot of exposure to pretty old vintage funds. As part of moving the tanker to a smaller number of managers, we’ll see pension funds globally, not just in the U.S. but in Europe and Asia, selling out longer-dated exposure to non-core managers.

We’ll also see continued interest in GP-led situations, not just restructurings … tenders, spinouts with assets from corporates or parent companies or financial institutions, and secondary direct sales, where GPs might sell a basket of assets.

On the LP side, we’ll see some sovereign wealth funds tactically reallocate and large pension funds … these are the two main sellers at the moment.

Photo of Mark McDonald courtesy of Credit Suisse