Episode 279: Overview Of the Private Equity Market: Today’s Changing Landscape

 

Stewart: Welcome to another edition of the InsuranceAUM.com podcast. My name's Stewart Foley, I'll be your host. Hey, welcome back. It's great to have you. Just to start off with a little housekeeping announcement. We have sent out some invitations to our ABM Real Estate and Infrastructure event, in May, in Philadelphia. It's May 7th and 8th. And if you are someone who's a specialist in that asset class and did not get an invitation and would like to attend, and you're an asset owner, an LP, we're full on GPs, just send us a note to events@InsuranceAUM.com and we'll be happy to get it in registration packet headed your way. 
And that leads me to a terrific podcast today on a topic that we don't get to talk about a whole bunch. And the title of the podcast is ‘Overview of the Private Equity Market in Today's Changing Landscape’, and we're joined by Champ Raju, who is the managing partner head of private equity at PPM America Capital Partners. Champ, welcome. It's great to have you on. I want to talk about your bio in just a second, but first I want to say welcome.

Champ: Well thanks Stewart. I appreciate the opportunity to speak with you today. I'm looking forward to the conversation.

Stewart: Yeah, it'll be fun. So just a little bit of background, I typically don't do this, but I think it's a good idea because sometimes it's not clear when our guests give their background that we cover all the important points. So you are a managing partner and head of private equity at the private equity arm of PPM America. And you've also spent time in the audit group at PricewaterhouseCoopers, which means you've got an accounting background someplace. You have a master's degree and an MBA from Northwestern University, a bachelor's degree in accounting finance from Indiana University. Impressive credentials all the way around, but I got to know this. Where'd you grow up and what was your first job? Not the fancy one. That's where we're going to get started and then we're going to launch into the asset class.

Champ: So for me, I grew up in a relatively small town in the middle of Indiana. It's called Marion, Indiana. It's about 60 miles northeast of Indianapolis. Marion was a very blue collar town, so a lot of factories, a lot of industrial type work around that area. For my first job was I was probably 12 or 13 years old and we lived in this neighborhood that had about 40 or 50 homes. And when I was 12 or 13, my parents ended up buying this riding lawnmower tractor for us to cut the grass at our house.

I thought maybe I could use that as a way to earn a little money. And so I ended up knocking on some doors and ended up with just a couple clients. I started mowing yards in the summer, and then took that and then moved that into the fall and started raking leaves for those same families. After a few years, I ended up joining a local golf course in the lawn care maintenance program. So I'd be up early in the morning mowing the greens and doing stuff to keep the golf course in tip-top shape. So that was really my first job if we rolled it all the way back.

Stewart: That's interesting. That was my first job, really, too, was working for my grandfather, and we lived on 11 acres. He kept it like a park. Well, we kept it like a park and I was just a kid and I was just labor. That's all I was. It's just like here, ride the tractor, sharpen the blades, change the oil and tractor, refill the trimming line on the weed eater, all of that. So I can really relate to that. So thanks for sharing that part of your background with us. We have had PPM on the podcast before, but I'd love it if you could give us a reminder on PPM and PPM America Capital Partners in particular.

Champ: Sure. So, let's start with PPM. PPM is an asset manager based in Chicago, Illinois. The overall company manages about $70 billion in AUM spread across various asset classes including fixed income, investment grade private credit, commercial real estate, collateralized loan obligations, and my group, which is PPM America Capital Partners, really focuses in on private equity.

As we think about private equity, we think about it in three buckets. For us, we invest what we call in primary funds. So we make investments in other private equity funds. The second leg of our stool is really co-investments. What we do is we partner with PE firms when they need additional equity to close deals, they might come to some of their LPs and ask if they'd like to take specific investment in a particular deal. And so that's another portion of our program.

And then the third part of our program, which we started relatively recently as we got into the secondary market and we're really leaning in right now in that market on the single asset GP-led side of things. And so that's kind of the overview of private equity. We've been really doing this since the mid-90s here at PPM and our team today has 9 investment professionals with the average tenure of our partners being about 20 years. So we've been here a long time, we've been doing the same thing for a long time and we think we have a really good and stable program and growing program. 

Stewart: That's super helpful. So it's interesting because a lot of folks that are on fixed income side of the world, and so I'm glad to be able to ask you this, which is can you give us an overview of the current fundraising environment and deal activity? Because this market is one that I'm not as close to, very honestly, and I think some of our listeners might not be as close to it either. So it's kind of like can you start with a little bit of the bigger picture and then work us into the details?

Champ: Sure. If you think about it today, we'd say the fundraising environment M&A activity is starting to pick up. If we rewind the clock a few years, and you think back to 2022 and 2023 where there was a lot of volatility in the public markets, the Fed started raising interest rates, deal activity really slowed compared to 2021and the few years prior to that.

What we're seeing now, the Fed has started to reduce interest rates a bit last year, and there's been a bit of stability in the public markets. What we're seeing now is M&A activity is starting to pick up. When M&A activity starts to pick up, so do distributions. Part of what private equity sponsors out there doing is they're making investments, but they also need to return capital to their LPs so that when they're out raising their next fund, their LPs have additional capital to invest with them.

So as M&A activity picks up, distributions pick up, we actually think the fundraising market has stabilized and will now start to pick up here in 2025 and forward. That's a quick overview of where things stand today, from my perspective.

Stewart: That's super helpful. So Champ, earlier you mentioned co-investments and I kind of think I know what they are, but I'm not entirely sure. So what I'd love for you to do is just with some relatively large crayons, give a definition of what is a co-investment and then I've got a couple of follow there.

Champ: Sure. Let me start by also introducing what is a primary investment because the two primary investment and co-investments kind of go hand-in-hand. A primary investment is where me as an LP would invest in a GP or in a fund. And let's say that fund is a billion dollars, so we make a commitment to there and then that GP would go out and probably want to do, call it, 10 deals in that fund. As an LP, you have really no insight into what that GP is going to do in terms of where the investments are going to be. We consider that blind pool.

So where the co-investment comes along is when a GP has a deal that requires more equity than what they're willing to hold in one particular deal in their fund. Let's say a GP has a max contribution of a hundred million dollars for any one deal in their fund, but in order to close their deal, they need to raise $150 million of equity, so the $100 million from their fund, and then they need to source another $50 million of equity.

That's typically where a co-investment opportunity comes into play. What that GP will do will typically go out to their LPs and say, "Hey, is anybody interested in taking a portion of this additional $50 million of equity in this one particular company really outside of the fund structure of your previous commitment?" And that's truly what a co-investment is and why that's a co-investment is in that instance, the LP does not typically have to pay a fee or carry to the GP on that. So it's done on a fee-free, carry-free basis as we like to say. And that should be a good way for an LP to get additional exposure to deals for their overall portfolio.

Stewart: Super helpful. So, I guess, two questions here. One is, as an LP, why would I do that? And secondly, as a GP, why would I do that? You kind of explained the GP side of it. But is it typically where the GP needs some additional capital to get access to a particular deal? I can understand how that works. As an LP, why am I interested in this structure?

Champ: Yeah, so from an LP side, one of the main reasons you're interested is maybe what I just referred to very briefly, which is when you're doing a co-investment, it comes on a fee-free carry-free basis. So if you're building your portfolio, and you can put a portion of that call at 10%, 15%, 20%, 30% into co-investments as opposed to just primary fund investments, you're generally reducing the overall fees necessary to invest in private equity at the end of the day.

Stewart: Can you just define the fees and the carried interest if you can just, I don't think you want to quote fees, but just generally if I buy a primary fund versus the co-investment, what are the fees going to look like in the primary? Like a range, just a big range.

Champ: When you generally invest on the primary fund basis, you're typically paying GP somewhere between 1.5% and 2% annual management fees. And then there's also an incentive fee paid on the gains of the overall fund, which is typically up to 20%.

Stewart: And so if I'm involved in a co-invest deal, then I won't incur those fees. Is that fair?

Champ: Correct. In most instances, GPs do not charge fee and carry to their limited partners on co-investments.

Stewart: Got it. Okay. And so what it gets me to, and I've heard this term, but I don't know what it means. So this is basically like me going, "Hey, I don't know what this means. Can you help me?" So my understanding is that there is a growing trend of GP led secondary deals, and can you kind of talk about what that is, and specifically the term I've heard that I don't understand or don't know what it is a single asset GP led deal. So can you orient me there?

Champ: Sure. And there's a lot of similarities between co-investments and GP led secondary deals. So what a GP led secondary deal is, think about a private equity sponsor who's already made an investment in a company, it's in one of their funds. And that deal in most instances is what we call a star performer or a trophy asset, meaning it's performed really well, the fund is going to make a very nice return on that, and there's probably a lot of runway on that business to go for the next potential investor.

Now, as we talked about earlier, the GP is in the business, are making investments and also selling investments to return capital to their LPs. And what is starting to happen over the past few years, and it's been around for a little while, but it's really starting to gain steam in probably the last three years or so, is this concept of the GP seeing that asset in their portfolio, which again is a trophy asset in their minds saying, "Hey, I could take this to market and sell and make a really nice return for my LPs, but I also see the value that I could potentially bring for the next 3 to 5 years of this business."

So what they'll do is they'll effectively pull that business out of the fund. So take that one asset out of the fund and raise a separate pool of capital around that. And typically the way it works is the GP will hire an intermediary, they'll run a process and typically the leads who ultimately sets price and the terms of the deal is a secondary player. And so those secondary players come in, they kind of set the price of the business. The GP will typically invest their next fund in this deal as well alongside the secondary players. Then there's also typically additional equity that needs to be syndicated around as well to finally raise the full amount of capital. So that I know is long-winded answer, but is the way single asset GP-led secondaries are planned?

Stewart: It's super helpful. So if I'm an LP in the fund where the asset is being removed, am I being treated fairly on that sale? Is there an independent valuation? In other words, it isn't that the LP in the original transaction, there's a finite life to that, and so they're going to get paid out and then the trophy asset is going to go on to as a GP-led single asset.

Champ: Correct.

Stewart: Is that right?

Champ: Yeah. Are you being treated fairly? And I think the answer generally is yes, because typically LPs get options to roll their investment. So if you do the analysis, which is not an easy analysis to do, but if you're able to do the analysis as an LP and you say, "Hey, I really want to stay with this business," you can simply roll your investment into that GP-led single asset continuation.

Stewart: So there's optionality.

Champ: There's optionality, and that's the way most GPs are doing things these days. And that's the fairest way to do things. Does the GP get the ultimate best price if they went to a full-blown auction? Maybe, maybe not, hard to say, value's always in the eye of the beholder. And so it is a process. It is probably a fair price. Is it the top end price? Unclear in the market.

Stewart: Makes sense. So why does PPM like the GP-led opportunity set? I don't know if I'm asking that right, but you guys like this structure. Can you just tell us in as simple terms as possible why?

Champ: Yeah. So first and foremost, it's very similar to co-investment underwriting for us. So we've been doing co-investments for 30 years. The analysis you do at the end of the day on a co-investment versus a GP-led investment, a single asset GP-led investment is virtually identical. Second, what we've seen historically in our portfolio is some of the better performing deals that ultimately get sold to other sponsors continue to perform really well. 

And so we look at the market and we say, "Hey, we have a GP that's made an investment in a business, they've done really well in the business, they're going to make 2.5, 3, 4X times their money in a span of three to five years, and yet there's a significant amount of runway left in this company. And oh, by the way, they're simply going to continue to implement the exact same playbook that the GP has already done for the first 3 to 5 years."

So we think about it as kind of a unique risk reward opportunity. If that business was to transact to another GP, they're probably implementing a different strategy. So the risk profile is a bit higher there, but in these GP-leds, when the exact same GP is still managing the business going forward, we think you've reduced the risk and the return profile is actually quite attractive. I think the one downside if you think through that a little bit is you are having to pay economics to the GP in a GP led transaction versus a co-investment where there are no economics paid to the GP. So, that's the offset. If we think about kind of the fee structure, GP led versus co-investment, but the risk reward profile of how strong that asset is makes that trade worthwhile for us.

Stewart: Super helpful. Just as a reminder, the professor for a day is Champ Raju, who is the managing partner and head of private equity at PPM America Capital Partners. And so, Champ, just as we get toward the end here, talk us through a little bit about what's the takeaway on why as an insurance company I would be wanting to invest in a co-invest or a single asset GP-led deal, and is that in your mind the preferred way to access this market?

Champ: Yeah, so look, I think if you're a larger insurance company and you have a strong primary funds program, you should absolutely figure out a way to do co-investments for your program. One, we talked about earlier, it's a good way to reduce the overall fees associated with private equity for your firm.

Two, for us, we actually utilize it a lot to help us really underwrite our GPs when we're out there to make a new primary investment. If you work with them on a co-investment, you really understand how they look at deals, what is the true value they're creating through the investment period that they're holding the deal.

If you're a program that can't commit a lot of capital to private equity, I think one very interesting way to get access to private equity in a relatively diverse way is to maybe invest with a co-investment manager. Again, you get fairly broad diversification, 40 to 50 deals typically in a co-investment fund. You pay reduced economics in a co-investment fund and you're getting access to probably 20 to 30 different GPs in a co-investment fund.

So a lot of ways to think about how to invest in co-investments and depending on how large a program is or what your staffing is, but all things to consider as part of building an overall co-investment program or thinking about investing in co-investments.

Stewart: Super helpful. So, that's been an amazing education. Is there any takeaway that you want to leave our audience with, just to summarize? And then I've got a couple of fun ones for you out the door.

Champ: Yeah, so I think we've talked a lot about co-investments and a lot GP leds. I think these are areas within private equity that you need to be staffed appropriately with. These are investments that have quick turnaround times and quick responses to your GPs. And you really need to have a staff that's capable of underwriting quickly and can maneuver and be a value-added partner to your GP. So we think these are great places to invest in private equity. We think the market's moving more towards these GP leads, we're spending more time and investing more capital in this for our clients and we think it's a great spot to be going forward.

Stewart: And it's not to mention, and I don't mean to put words in your mouth here at all, but deal flow is a significant consideration, and deal flow comes with scale. So I think that is an important aspect of this asset class.

Champ: For sure. And so having been in the asset class for 30 years and having mapped the market and working with a number of different GPs, you have to be in the deal flow to access some of these deals. And we have very strong relationships with a lot of our GPs. We have strong relationships with the intermediaries. So our whole goal is to be shown as much as possible and then be able to self-select the best assets that we think fit our portfolio.

And so again, having that staff, being able to be in the market continuously helps with all of that. And so that is kind of paramount to making sure you're just not being showed a very small subset of the deal flow that's out there.

Stewart: Yeah, that's super helpful. So one of my fun questions is really, you've been at this for years, which is an amazing accomplishment by the way. I mean, I've been in the industry for 30 years, but I've had a myriad of jobs with terrific organizations, but I really commend you for being a specialist for that long. I taught for a number of years, and there were a lot of students who wanted into private equity, who wanted into investment banking, whatever, and there were some students who were successful, but my question is a guy in your seat that has seen, hired a lot of analysts and interns. What qualities are you looking for when you bring in new talent to your team?

Champ: It's a really good question. I think a couple things. You're writing and communication skills have to be top-notch. In our industry, we do a lot of writing, we do a lot of investment analysis, and so you got to put together PowerPoint presentations and write-ups and things that you ultimately present to investment committee. So as a baseline that has to be top-notch. Also, obviously your analytical skills have to be there. A lot of PE firms run a lot of models, so you have to have a very strong proficiency in Excel and being able to model as well.

Stewart: Is Python helpful?

Champ: Not particularly in how we run our business today. I am sure there are some firms out there that probably do use it. As we look at our business today, we're really more Word, PowerPoint, Excel gets us through what we need to do for our work today. Then communication skills are incredibly important as well. At our firm we have our youngest people present investment committee for us, and so to being able to articulate and get your messaging across in terms of pitching a deal is incredibly helpful.

And then finally, you have to be a good team player. Most people that are in private equity, they work long hours. You work in teams and being able to work with multiple different teams with multiple different personalities and juggle a lot of different things at once is very critical to being successful in private equity. So I would lean in on those kind of attributes as we hire and look for folks, we try and get down to that level and see if they have all of those skillsets.

Stewart: That's super helpful. Thank you. All right, so here's your fun one on your last one. So lunch or dinner, table of four. You can invite up to three guests, alive or dead. Champ Raju, who do you want to have lunch with most? There's others on this call that are listening. I'm sure that any of us would be happy to be joining you, but I doubt that we're going to make the cut. Who's your one, two, or three guests?

Champ: Yeah, interesting question. I haven't really thought about this one. What I've always thought of is just to meet people, what would be a great group of people to kind of bring together just to hear different avenues of thoughts. And I'm sure probably a lot of people will say the same thing, but if you threw someone like a Warren Buffett, a Michael Jordan, and I'm trying to think someone else, maybe like a Tom Brady or something, and bring them together and see how they all interact. Because I think folks at that level operate at a different cadence and level than most people. And to see how those types of folks would interact would I think be very intriguing to me and see where the conversation would go.

Stewart: What a great answer. We have had Buffett before. We have had, I think we may have had Jordan before, and I'm certain we've had Tom Brady before, but we've never had anybody want to put them all together. So congratulations on that innovation and really appreciate you being on, it's been a terrific education on private equity and really in today's changing landscape. So thanks for taking the time and thanks for the education.

Champ: Stewart. I really appreciate the time and the opportunity to speak with you, and hopefully it was helpful for folks.

Stewart: Absolutely. We've been joined today by Champ Raju, managing partner, head of Private Equity at PPM America Capital Partners. Thanks for listening. If you have ideas for podcasts, please shoot me a note at Stewart@insuranceaum.com. Please rate us, like us and review us on Amazon, Apple, Google Play, or wherever you listen to your favorite shows. My name's Stewart Foley. We'll see you next time on the Insuranceaum.com podcast.