Adam Frieman, Principal, Probitas Partners
1. You joined the New York office of placement agency Probitas Partners earlier this month, leaving behind a post at UBS where you developed the bank’s equity risk-management practice for public markets. Now you’re going to apply the same approach to private equity, helping the firm’s clients manage their portfolios’ risk characteristics by taking advantage of secondary markets and other tools. How does this kind of risk-management work for private equity? Isn’t it easier in public markets because they’re more transparent?
I’m not sure I would categorize it as more transparent. It is easier to see because there’s a stock price and there’s a graph that can show you price performance and P/E performance and return-on-equity performance. But I don’t think it’s necessarily different in private equity, because funds report their results on a periodic basis; deals make it into all the press; and when a deal blows up people know who provided the debt and people know who are long a bad asset. You can find much of the same information.
2. What is the difference?
It’s just that it’s an illiquid market as opposed to the liquid public markets. That doesn’t mean that you can’t provide risk management measurement or advice or tactics to optimize your portfolio.
3. Are institutional investors catching on to this model?
One of the themes that I think is here to stay—and it’s been evolving over the last few years—is the buy-and-hold strategy for pension funds and institutional investors and limited partners is no longer just a passive strategy. In fact, it carries risk. Doing nothing carries risk. Over the last 36 months, with the proliferation of secondary funds that have come to market, you’re seeing that limited partners have become more proactive in rebalancing their portfolios. I don’t think we’re as ready for a derivatives market for private equity as we were in the public markets, but I do think there are tools to mitigate risk or to change portfolios, and now there’s a secondary market evolving that allows people to become more proactive.
4. But we’re still a long way off from derivatives?
I don’t know if we’re a long way off, but we’re a ways off. The reason is that generally derivatives require liquidity for the provider of the derivative to rebalance its hedge. People tend not to offer derivatives unless they have an ability to hedge. How do you hedge a private equity portfolio if there’s no publicly traded market? Well, there’s a secondary market, so there is some growing liquidity and that’s certainly important. But I don’t think there’s necessarily enough liquidity for a derivatives market to develop in private equity. One of the things that I think is inevitable is the convergence of the private equity and public equity markets as we’re seeing with big LBO funds going public. It’s a matter of time. I think this is an evolutionary process. I ultimately think you will see more risk-management tools that are available in the public domain become available in the private domain. But we’re just not there yet.
5. Are there other signs of maturation of the industry?
I don’t know that it’s a maturation. It’s reaching a critical mass in the growth of the industry. Maturation implies that you expect returns to decline or opportunities to be less interesting. We don’t see that at all. I think when you look at the evolution of private equity, this is a natural next step to look for ways to create liquidity and risk-management opportunities.