E28: Private Equity Secondaries with Robert McGrath

Hey, cool cats. This podcast is brought to you by Gensler Wealth. The information discussed today is meant to be general in nature and not tailored to your specific investing circumstances. This means that you should talk to your regular Gensler wealth advisor or your own advisor before acting on any information we discuss today. Nothing in this podcast is intended to be a solicitation and past performance does not guarantee guarantee future returns. Yes. Disclaimer. I do have a bit of a cold, but it makes my podcast voice smooth. Today on the limited podcast, we're talking about private equity secondaries with Rob McGraw. What are they and why they may be an even better way to invest in private equity funds. Let's go, Sam. Well, welcome everybody to the unlimited podcast. We've had a couple months now, really over the summer, where we've veered a little bit away from investing topics and it turns out that even though I want to try to share some other information with the world, the investing episodes tend to be the most listened to and the most in demand. So it's September, we're back in action. Everyone's back at work. We're getting serious now.

So.

So now we're back on the investing theme and excited to have with US Today Rob McGraw, who is the founder and managing director of the Toronto based secondary fund Overbay Capital Partners. And of course we're going to explain what that all means. But today we're going to talk about private equity secondaries, and that is one of the fastest growing strategies within the private equity space and a really attractive way arguably to invest in private equity right now. So looking forward to sharing this topic with you. A few more bits of intro to Rob. Rob began working in secondaries almost 20 years ago, when the secondary market was still in its infancy and a tiny fraction of its size today. Prior to forming Overbay, Rob worked for 12 years as an intermediary in the secondary market at Setter Capital, where he advised institutions on buying and selling private equity funds. And over that period, Rob was one of the most prolific secondary deal makers in the world, completing over 700 transactions representing more than 20 billion in value. In 2016, Rob decided to move from the agent side of the business to the principal side and formed Overbay to invest in secondaries. Fast forward seven years and today Overbay manages almost $2 billion in assets on behalf of institutions and private investors. So really excited to have Rob here. Rob, thank you very much for making the time.

Thanks very much, Brian. Quite an honor to be invited.

Thanks. And so, and maybe if my listeners can tell or hear I've got a little bit of a rasp or a sore throat going on here. As in past episodes, the show must go on. So bear with me if with my sort of deep, raspy voice. So we're going to talk about private equity secondaries for a good part of this podcast. It's maybe a different asset class than many folks have heard of before, but before we do that, I think it's important to first talk about what is private equity in the first place. And my listeners know we tend to like to go back to basics, as they say. We don't assume everyone knows what all this stuff is. So Rob and I, and by the way, we also want to hear a bunch more about your background. But I actually think maybe we talk about private equity first and then when we get into the secondaries part where you'll explain overbay, maybe that's a good time for you to give the story of how you, how you arrive there. So why don't we just share with our listeners, you know, like, what is private equity? And maybe we'll dive into a little bit of the characteristics of private equity.

Okay, and, and you know, I can go many directions with that question, but what I would say is maybe looking at public equity or publicly traded stocks to kind of compare contrast. So public companies, you can buy them on the stock market any day at any moment, and conversely, you can sell them, they're broadly held. And when you invest in a public company like Apple or Microsoft or what have you, you're investing as a passive investor and you're just hoping that that investment goes up while you own it. With private equity, these are privately held businesses. And, you know, there's, there's many tens of thousands of private businesses. Most of them are owned by the founder or the founder and, and his or her family. Private equity are private businesses that are owned by institutional investors, for the most part, private equity funds. And so these private equity funds will own private companies. They can be small, early stage technology companies that, you know, someone has a great idea and they, they want to turn that idea into a business and a venture capital fund might back them. Or it can be a very large business with hundreds of millions of dollars of revenue, and, you know, it's backed by a mega private equity fund like a Blackstone or Carlyle. The, the difference beyond just the institutional private equity fund owners, you know, the average individual investor, you know, can't invest in those companies. So that, that's one thing is that, you know, this is a market that's really restricted to institutional investors and private equity funds. The other thing I would say is that the style of investing is active. It's truly active. So a private equity fund, when they invest in a company, they're not just, you know, waiting, sitting around, waiting for dividends to come or that company to go public through an ipo. They're, they're actively getting involved with the business. They're often sitting on the board. They're, they're hiring senior management, sometimes firing senior management. They're helping the companies execute on a business plan. These private equity funds will often be led by real industry experts. And so these are people that come with a playbook and they know how to scale businesses or how to cut costs or what have you. So it's very much a case where private equity funds get their hands dirty and hopefully create a lot of value for themselves and their investors. You know, the other thing is that public equity, as everyone knows, can be quite volatile, particularly over the last year or so. Private equity is valued in a different way. You know, generally private equity funds were backed by institutions like pensions and endowments and the like. They produce quarterly valuations for their investors. And, and it's based on the value of the business as a whole, how that business is doing, how they project it to do over the future. So it's just, it exhibits a lot less volatility compared to public equity. But, you know, there's many other differences. But I don't know, Brian, if you think that that's kind of. If I. Let me know if I should cover any other aspects.

No, no, no, that, that's good. And I think you point out a very important piece, whether it's, you know, visible to folks or maybe it's happening in the background. But you described as potentially lower volatility, I guess, for folks owning private equity, because really, as you say, they only price their story value, their holdings generally about once a quarter. It's, it's, it's not the same as the stock market that is valuing every single company every single second from, you know, 9:30 till 4:00pm every day. And so it goes all over the place. I always like to say those private equity holdings are also moving around every second of every day, up and down, all over like crazy. But because you don't actually see that, and you only see the prices four times a year or sometimes twice a year, sometimes once a year, depending on what it is, people feel much more calm and relaxed, maybe owning private equity and same thing, actually, people say a lot about owning real estate you know, oh, I have a building, you know, I can feel it, I can touch it. And by the way, the price is very stable. Well, it's not. It's actually moving around like crazy like the public equity as well. But you never have the opportunity to see that price and act on it, except for you know, ever so often a few times a year. So it's an interesting characteristic to share, I think.

I couldn't agree more. And yeah, we'll probably talk more about this topic of illiquidity. But when you invest in private equity, you generally don't have the ability to redeem on demand. There are some products that offer that,

but

between the lower volatility that it exhibits that helps you sleep at night and the fact that you have to live with these investments over time, you know, it could be a good investor experience, but also it can save people from themselves. You know that we can all be emotional as we invest in anything, particularly public equity.

What's the size of this, the market for private equity in any given year or in total? I don't know how you think about the size of this market.

So it's quite large and growing quite quickly. Growing quicker than public equity is, for that matter. So depending on how you define private equity, because there's a myriad of strategies that people consider to be private equity. It's call it somewhere between 7 and 9 trillion dollars globally, and it has grown as an asset class something like sevenfold over the last 20 years. Meanwhile, public markets, I think have tripled in value. They've grown as well, but just not nearly as dramatically. And there's a growing trend amongst institutions to put more and more of their capital into private equity.

Well, and actually so on that, on that point, I know every institution is different. You know, you can't really say one single number or pinpoint it. But do you have a sense of what some of the largest, you know, major institutions, pension plans, endowment plans, et cetera, are allocating to private equity in their overall portfolio, for sure.

And it's kind of, it's often private equity firms when they're doing fundraising, often part of the pitch is look at what the world's biggest and smartest investors are doing. And so we see these stats all the time, and I know them more or less often well by heart. But, you know, take CPP for instance, their target allocation to private equity.

And CPP is the Canada pension plan, the retirement plan for all Canadians, just for those who may not know.

Exactly. And one of the world's biggest investors, they manage over 500 billion on behalf of Canadians. So they allocate or their target asset allocation is roughly 25%. So it's a huge weighting in their portfolio. If you look at the biggest U.S. endowments, you know, say Harvard or Stanford or Yale or what have you, it's, you know, in the order of 25 to 40% across private equity and venture capital. Wow. So it's far and away their biggest asset class, their biggest source of returns, at least historically. And, you know, there's a variety of reasons why they, they have chosen to go into private equity and it's worked out quite well for them. But if you look more broadly and say, okay, what's the average US Pension's allocation to private equity? Which is a bit more than the average Canadian pension, I think it's in the order of 9%. So, so call it, you know, the pensions will allocate between 5 and 15% to private equity. And then if you look at family offices, they tend to invest more in the order of 20 to 25% in private equity. So it's very significant in that demographic

and versus traditional, let's call it, the regular investor out there.

Yeah, it would be perhaps, you know, a fraction of a percent if you, if you average tends to be, you know, most people have zero private equity exposure. And then, you know, a small but perhaps growing cohort of wealthier individuals will have some private equity. But it's a very small, outside of the, you know, the large single family office type investors.

Right. So I think that's an important point. You know, as you described it. So and as the world, as many folks would say, the smartest investors in the world, they sort of put the category of the big pension plans and endowment plans and Harvard and Yale. Exactly what you said. Some people describe those as the smartest investors. They've got 25 to 40% family offices, which tend to be wealthier, higher net worth, have, as you say, pretty reasonable sizes. But the average regular investor, and I see this, you know, every day in terms of some of the folks where, you know, that may be coming into our door and saying, can you help us? Most folks have zero allocation to private equity. So there's a, you know, it's just a question not to get an answer from you, but just to put out there is why is there such a difference? Well, actually, maybe it is a question to put to you. Why is there such a difference between what, you know, the regular investor and some of these quote unquote, smartest investors is private equity. Not easy to access. Like what's, what's the challenge?

I, I would say that, you know, a few of the main stumbling blocks. So one is most individuals have simply not had the opportunity to invest in private equity. It's not been on offer. I mean, if you're in Canada, you know, chances are you've been, you get investment advice from one of the big five banks and they have not been offering alternative assets to their clients, at least for the longest time. So it simply wasn't an option. But those that were offered it, I think what they would find somewhat off putting is, if not very off putting, is that it's, it's a liquid, long dated asset class. So you know, if your CPP or the Canada pension plan or the Harvard endowment, you're managing money with the perspective that you have almost an infinite time horizon. Every year Canadians are contributing to the Canada pension plan and you're trying to really build wealth for investors or sorry, Canadians, 50 years out from now. So they have a very long time horizon. It's a really different perspective. If you're the average individual looking at a private equity fund that might lock your money up for 10 to 15 years and you're 55 years old, you know, that's, you're not going to feel as comfortable having your money tied up for that long. The other issue with private equity, I would say is it's very high risk. So we haven't talked about, you know, how it's private equity returns, but I would just highlight that, you know, if people look at private equity and they look at the average returns, they'd say, wow, those are amazing returns. But if you look at individual fund returns that make up that average, they're all over the map. And, and it's really a story of home runs and strikeouts that on average people have a good, a good experience. So that, and then, you know, final thing might be, it's a, it can be a esoteric asset class. And Canadians, I've heard often really have adopted real estate investing. It's much more intuitive and tangible versus do you want to invest in some young company with no revenue and a cutting edge technology operating some cutting edge technology. And by the way, there's a 75% chance that that little business will go out of business. There's a 25% chance it might be 10 times worth, 10 times your investment. But you know, that, that I think is, it's just natural that investors would gravitate towards real estate, maybe credit funds more naturally, but private equity I think increasingly is on investors minds.

Right. So maybe talk a little bit about what the, what a typical private equity experience is from start to finish. And if I, let's call it the lifestyle or I know, you know, you talk about something called the J Curve, like what's it like if you go into a regular private equity fund day one, like how does that look over the next number of years? And I think you already alluded to 10 plus years. How does that go?

Yeah, and, and this is, I mean podcasts are an audio medium so you know, would be helpful to have a chart to go alongside this description. But when you invest in a private equity fund, you're not actually investing money, you're committing your capital. So you might go to a private equity fund and say, okay, I like what you're doing. I'm going to commit a million dollars to your new fund alongside a number of other investors. So let's say that that fund manager raises $200 million. They're going to go look for companies to invest in that fit their mandate and that might take them upwards of five years to find enough companies to construct a portfolio.

So, so, so sorry, just, just a quick thing which I think is important for folks to know. So you're investing it, you, you invested your million dollars alongside, you know, 199 million other dollars there, but you have, there's nothing in the pool or in the fund right now. So you, aside from the fact that you know, the manager we hope is very good and smart and you have and has a mandate to look for companies that look like something that they've described, there's nothing there. So I think they call that a blind, essentially a blind pool or you know, you have nothing to look at to know what you're going to be investing in.

Exactly. And in compounding that, you know, you're investing in this blind pool and it's a very long dated investment strategy. So you have to hope that the future many years out from now is going to be, you know, benign or positive for this investment strategy. Statistically, a manager that's done well, that, that's produced really good returns in their last fund is actually slightly statistically more likely to underperform in their next fund. So you know, you invested because they hit it out of the park, but you have something like a 52% chance that they're going to deliver below average returns in their next fund. So it's, it's a very unpredictable asset class.

But, but sorry, I, I interrupted you. So you were saying you get in and it's the first five years they're going to look for, for some investments.

Exactly. So they're going to go look for companies and you know, they're going to invest that capital in increments as they find each company and that they might support those companies with giving them additional capital to, to grow their businesses. The other important thing to know is that the manager is charging management fees because they're out there doing all this work. They're looking for companies to invest in. They're, they're spending a lot of time with their portfolio companies. They're charging fees on the entire committed amount. So that investor has committed a million dollars, that manager's gonna charge fees on that million dollars. But there's, at least on day one, no value there. So you're paying fees, but you don't actually have your capital invested yet. You don't know when you're going to have to fund that million dollar commitment. But you know that it's going to come in small increments called capital calls. And so you might say, okay, you get a notice out of The Blue, in two weeks, send $100,000. Nothing happens. You fund that and nothing happens for another six months. In two weeks send us 200,000. Nothing happens for a year, and then you get another a hundred thousand dollars capital, et cetera. And so it's often for investors frustrating because they got excited about this investment strategy and it took forever to actually get their money deployed. The other thing is that it's hard to manage that commitment or can be challenging because it's a liability. You've agreed to commit your capital, but you just don't know when that capital is going to be called. So that can be tricky for investors to manage. They need to often earmark a certain amount of liquidity for that investment. And one criticism of private equity would be, yes, you can look at that fund's returns over its life and it might produce good returns. But if you took a more full picture and said that investor had to set aside a whole bunch of cash that wasn't doing anything while they're waiting for their money to be deployed, the returns don't look so good. But yeah, among other things, that can be frustrating. And it's particularly frustrating if you are an individual investor. I think if you're a pension, you know, you have a massive team that's managing these cash flows. They're, they're very much, they have the time in their day to call the managers and just know how to manage all of this quite well. But for individual investors, it can be frustrating and complex. Oh, sorry. I was going to say I'm talking about the early years, which are the least fun years, and that's the investment period. The manager at the end of the investment period has selected the portfolio companies that they want to invest with. They're starting to work with those CEOs or presidents of these businesses to execute on business plans, and they're helping those companies hopefully grow in value. That investment period might be five years, and then the next period might be the development period, where it doesn't necessarily work in a straight line like this always, but they work with these companies for a few years, and now those companies are much bigger than when they initially made the investment. And the manager is going to look to sell those companies, and this is known as the harvest period. So it might be in years seven to 12. And the manager is looking at their companies and saying, okay, we've created value. Market conditions are good. Should we take this company public on the stock market so we sell our stake to a broad array of public equity investors, or should we sell this company to a strategic buyer, some big company that wants to get into that space or consolidate an industry, or should we sell it to another private equity firm that deals with bigger companies? And that's often the case is that one private equity fund will sell to a bigger private equity fund and perhaps even to a bigger one yet. And that's another form of liquidity for that, the original fund investors.

And so what's the, I mentioned this thing called the J curve. What does that mean? Or how does that work?

And so that really means that if you looked at the cash flows in the first five years, you're, you're just funding this investment. So you're sending cash out. It's cash flow negative at about years. You know, call it 7, 8, 9. It's switched. And you've got, you're getting money back rapidly, hopefully in this harvest period. And maybe you've got all your initial investment back by year seven, eight or nine, and then you're making a gain on your investment in the subsequent years. So it's really that dip of you're funding new investments and you're sending money out, and then it's coming back up. And on a graph, I'm probably not painting a real clear picture, but it looks like a jerk, more or less.

Oh, that's good. So, okay, so that's. So that's good. So you've given an overview of private equity. We've talked about some of the benefits of it, lower volatility, maybe you get some good returns and a whole bunch of other benefits, for sure, and also some of the challenges. So we may, we made our listeners wait, you know, in anticipation for your story of, of, you know, your background and how you got here. But do you want to talk a little bit about now, your background and the path to overbay and what this whole notion is, what this thing is called private equity secondaries? What does that mean? And then I'll ask you a whole bunch more questions about. About those.

Sure. Maybe I'll describe a secondary market and I could talk a little bit about my history with it. So private equity is this massive asset class, as what I was saying earlier, seven to nine trillion dollars of value. And it's an illiquid asset class. If you invest in private equity fund and you decide you want to get out of it, you don't really have many options. You generally, I mean, there are some funds that have redemption features, but you usually cannot redeem it. It's not like a mutual fund and there's no stock market to sell it on. So, you know, to get liquidity, you have to do what's known as a secondary sale and you have to sell to a secondary buyer overbay. My firm, a secondary fund, we're among that group of buyers out there. But it's an unusual event. I would say in a typical year, private equity investors might sell 1 to 2% of their holdings on average. I mean, across the entire. Not everyone's selling it every year, but if you aggregated the value that trades, it represents about 1 to 2% of the entire asset class. If you looked at the stock market, I think the s and P500, about 60% of it turns over in a given year. So it's dramatically less liquid. When an institution wants to sell a private equity fund, there's a lot of friction cost associated with selling. So if you want to sell a stock, you can sell it for essentially nothing through a discount broker and execute immediately. If you want to sell a private equity fund, generally speaking, it's going to be very time consuming. You usually have to convince your board, if you're an institution to support that decision. You're going to have to hire advisors. You might hire an intermediary to help you sell it. You hire lawyers and you it will take often from the time you say I want to sell this thing to getting your money, it might take three to nine months. And so it's time consuming, costly, and it's a market that is more is defined by discounts more than anything. So again you sell in the stock market, there's no discount in the secondary market. It's very common that institutions have to accept some discount. You know, it might be 5%, it might be 50%, but it's a market that's very much defined by discounts.

Should we talk about now why would an institution want to sell this thing or should we wait till maybe you describe go through what you.

No, no, I think it's an important point because I'd say that because the friction costs are quite high. It's really something that institutions try not to do. It's not top of their list to, to.

Right. So why, so why would they want to do this in the first place?

You know, usually there's, there's a few scenarios. The most common one that we encounter is a new chief investment officer or a new head of private equity is hired at an institution and they come in and they say okay, I want to clean up this portfolio and make room for my picks. So some of these funds I would never have invested in or they're okay looking but I don't have room to invest in my, my preferred managers. So in their first year they put together a list of non core funds, they hire an intermediary, they conduct a sale, they sell at a discount. They go to the board and say, you know, long term you're going to thank me because I've sold these but I'm going to get us into some great funds. And you know that they're, they just kind of do that one time cleanup of their portfolio and they build capacity or, or, or room for them to be able to make new investments. And I would just, I'd highlight that example because it's the, it's one of the most common ones that we encounter. And although price matters, it matters less to that chief investment officer than you think it might because they usually have a grace, grace period when they're working new to an institution to really make room for their own picks. It's not going to affect their bonus. You know, it's, it's kind of, they want to get it done and they want to have an easier solution. So it's, I mean, I'm not a psychologist, but that's my, my sense of people's motivations. You then you have scenarios where a chief investment officer or other senior investment person look at their portfolio and they decide they really don't like something or some funds and they say, oh, this is trouble. I want to get out of it. But you know, and they try to sell what they consider to be junk. But those transactions aren't actually all that common or at least they make up a small amount of the secondary market because what the seller sees, the buyer sees. So if it's a troubled asset, the buyer is generally aware of that and they'll avoid it even if they can buy it at a steep discount.

That's what I was actually going to ask you if the new chief investment back, back when you were mentioning the first point. If the new chief investment officer comes in and cherry picks the funds they don't like for some reason, does that necessarily mean that, you know, maybe they're the underperformers or they're not good. So why would. What now on the flip side, why, if they're selling it, why would, why would you or another secondaries firm want to buy it? Would be the logical question to ask there.

Yeah, I, I think it's a great question. And I would say that the chief investment officer doesn't necessarily know what they're selling. They know it's not one of their preferred relationships and they want to make room for their preferred relationships. And they might make some sweeping assumptions on what they're selling. But as shocking as this may be, because these are often tens of millions or hundreds of millions of dollars of value, that chief investment officer is usually not spending a tremendous amount of time looking at what they're selling. And I'm probably not giving most sellers their due, but in my experience there's just kind of a we need to make room and we have high conviction in some other managers and that's we're going to sell and sell. Another. There's many reasons, but I'll just touch on a few. Another reason might be regulatory change. So financial institutions can find themselves in a position where, you know, an insurance company holds private equity and their regulator might say, oh, you know, we, we don't want insurance companies to have too much in these illiquid investments and there's regulations to, to support that view. And so suddenly they say we have to reduce it because of that. I'll give you two more. And then because there are many, but occasionally you have financial distress. And this would be more in the case of wealthy individuals where, you know, they're having issues, maybe their real estate holdings are need to be supported, they need to inject more capital or their businesses failing, what have you. But that, that comes up, it's not a huge dynamic aside from kind of crisis moments we saw A little bit of this last year. The big dynamic in the market right now is that institutions that had been big allocators to private equity and I, you know, Canada Pension Plan would be among it would be in this crew. They were big believers, they still are big believers in private equity, but they had their private equity portfolio performed so well that it became outsized. So Canada Pension Plan said, hey, we want to have 25% private equity. Well, it's outperformed and now it's more like 33% of their portfolio. And partly that's known as the numerator effect. The other, because we're talking about private equity, the value, private equity divided by the value of the portfolio. So that's the numerator effect. But the other side is you can have what's known as the denominator effect, where the rest of their portfolio has gone down in value, making private equity disproportionately large. So there's been both enumerator effect. Private equities outperformed for several years, and then over 2022, public equity and fixed income fell in value. And now institutions, the ones that were the biggest proponents of it, I mean, I think they all still believe in private equity as an asset class, but they find themselves having way too much and they need to get their allocations on the right side from a risk perspective. They need to have liquidity to pay pensioners or, you know, a variety of other reasons. But that, that's been probably the theme of the last year, driving secondary sales.

Perfect. I think I interrupted you telling a little bit about sort of how you got to here, I guess.

Yeah. So I had started my career in wealth management many years ago and did it for a few years, but decided it was not the career path for me. And I went back to school and I was working at one of the banks in a rotational program after getting a graduate degree. And one of my brothers, Peter, had discovered this thing called the secondary market. And he had been working for a few years. I actually didn't know what he was doing at the time. This is 2004. And he said, rob, come join me. And, you know, I, I need someone. My business is growing. And I said, no, you know, we were always raised. You gotta work at least two or three years at a job. You can't flake out on someone. I just started at cibc, you know, a few months ago. He said, I'll, I'll double your salary.

I said, so what time do you leave away?

Yeah, flake away. So anyway, so it Was I would give all credit to my brother Peter for discovering this obscure area of finance. And his background is much more interesting than mine and unconventional, but you know, in the interest of time and self promotion, I won't talk about, um, but

maybe should we cancel this now? We'll get your brother on for the second.

Yeah, exactly. If you can upgrade.

Nice talking to you, we'll see you later.

But he had this light bulb moment around 2000 when the, the dot com bubble was bursting and he was reading about venture capital and a trade magazine on, on vc and there was some article or advertisement for a firm called Paul Capital, which has since gone out of business, but they're a secondary fund. And they were saying if there are any endowments out there or other investors that want to sell their venture capital funds, we're buyers. And he decided to reach. He had no finance background. He reached out to them and said, would you pay me a finder's fee to find you deals? And they said sure. And he decided, but they wanted him to be exclusive, which, which he didn't think made sense. He had no idea about anything in the world, but he knew enough to not be exclusive with the first firm. But he basically, and this is really before there, there were databases of institutional investors. He decided to call around and see if there were other firms that would like to pay him for deal flow and then decided, okay, I've got a bunch of people that pay me success fees if I find them deals. Now let's see if I can find sellers. And he had a small group of cold callers operating at Bathurst and Lawrence and calling the likes of Citibank and Harvard University and others. And he, groping around in the dark, found decision makers and they were ready to take his call and found sellers. And one of the biggest endowments in the world was one of his first, you know, first transactions. They, he, they wanted to sell, I think $60 million of some prominent venture capital fund. And he got paid something like $450,000 to broker this trade. So he, whatever he was doing at that point stopped and he discovered, you know, a rich vein of business. And anyways, he invited me to join him and the two of us alongside a team that grew over the years, we, we just kind of mapped out who were all the decision makers in the world. And you know, I'll say it, we were told it many times people would be going to do fundraising in, you know, the Middle east and some family no one had ever spoken with, but they, they would know that the Brothers in Toronto, that new secretary. So we, we really made it our thing to kind of know everyone and know who oversaw private equity. And I would get up literally at 2am, start my day cold calling Singapore and then kind of work my way around the world and end up in California or Australia, depending on the time of the year. But it was, it was, it felt hard to get deals done but it was actually incredibly easy. There just weren't intermediaries, there were very few buyers. It was, you know, an opaque market, somewhat taboo to sell, but, but yeah, did that and you know, over that, let's say there was a few billion traded, maybe $5 billion traded globally. Now there's something like 150 billion, 100 plus billion traded a year. So the market's growing up a lot since then. It's become more competitive, certainly at the bigger end of transactions and what have you and people via LinkedIn and you know, the world is much more connected. But yeah, Brian, that big, big digression from.

No, no, that's good. So, and so basically you took that experience over sounds like many few decades and sort of evolved into overbay where you're the manager now directly buying the secondaries as opposed to being the person matching up the buyer and the seller.

Exactly. And it was, you know, it's great to be a middleman in a bit in a growing market, but over the years I felt like I could spot a good deal and I really wanted to put my money where my mouth was. And you know, while the bigger end of the secondary market was getting more and more efficient, certain pockets of it were persistently inefficient and we were paid by secondary funds to find the deal flow. And I think that's a huge part, my biased former intermediary opinion, that's a big part of the value creation is just finding good deals. And so I decided to use the skill set, the network and so forth that you build over the years in that role to be a buyer and hence setting up this firm seven years ago.

So we talked a lot about private equity pluses and minuses. We talked about your path to starting and now running overbay for many years. And we talked about why institutions might want to sell their private equity to a secondary buyer. So now the, you know, the, the million dollar question of course is now tell us why private equity secondaries is actually such a great asset and how does it differ from regular private equity? Where do you buy, when do you buy? Why is this good or better? I assume you would say it's better maybe, maybe than regular private equity, but I'm not going to put words in your mouth. So maybe share with listeners sort of some of the characteristics of secondaries and the good, the bad and the ugly there.

Sure. And, and I, I think that a lot of the drawbacks of private equity I was describing earlier can be mitigated or overcome through secondary investing. So one part of this is when you buy a private equity fund, you're generally buying it when it's, call it five to 10 years old.

So when you're on the secondary side,

when you're buying on the secondary market, it's, you know, occasionally you buy newer funds, or one could buy newer funds, but typically you're, you're buying these when they're, they're fully invested, they're after their investment period. So first benefit is just visibility. You can see what you're investing in. It's not a blind pool.

Right.

The second is you're investing all of your capital in that transaction upfront. You're not making this commitment that's going to be drawn over several years so that gets your money working right away. The third would be that because you're skipping the investment period, you're coming in in year five or year seven, it's really shortening the duration of your investment. And, and if you're coming in, in what, in what I call the harvest period or what's called the harvest period, you know, the, the beauty is that you're coming in just when the going is getting good, you know, when it's the best period to own that fund. So it's when capital is coming back to you. And so you might buy into a fund for $10 million and then in the first year you're getting back two or three million dollars because that fund manager sold off some companies and the next year you're getting, so it's a very, it's, you gain the private equity experience, but on fast forward and, and I think that that's very attractive. And then you add on the dynamic that you're, you're often buying at a discount. It might be a modest discount, it might be a big discount, but that discount means that you've got some margin for safety, that those assets can fall in value to a certain degree before you lose your principal. But on the other way to look at that is it enhances your return. You know, that you're coming in at a lower cost basis. And so those assets are going to proportionately perform better for you. And you know, we, we have I think that's broadly speaking the benefits of secondaries. And then we have our own style of secondary investing which I'll just describe would, you know. And we're not, we're unique in some ways, but not unique in this particular way we look at for diversified secondaries. So we're not looking to buy a single company or a single fund and pick winners. That, that to us is not, it's not our strength. It's very difficult to do. We're looking for diversified portfolios and usually that CIO example, we're coming into a situation where the chief investment officer is selling a large portion of their portfolio. They're selling, in our typical deal, we're buying exposure to more than 40 funds in a single transaction and on a look through basis, exposure to more than 400 companies. So it's, we're going to invest in companies that are going to do poorly. We're going to invest in companies that are going to do well. Net net, you know, they should do well. But it really gets away from the risk of return dispersion that that dynamic of some funds are home run and others are terrible. And you know it. You're buying into the broad asset class. You're not betting the farm on any one thing which really find appealing.

Great. So maybe talk and I know we're getting a little bit tight on time, so maybe talk just for a few moments of how you actually, because you get the visibility, it's not a blind pool as you say, you know what funds you're buying, you know what companies they own. So what's the process around actually diving in and looking at those funds and determining if you like them or not before you buy them? Because as you say, if it's 40 funds and 400 companies, is your team looking at all the way down to the bottom and each company and figuring out, you know, valuation or how does that work?

So it's a, it's a mix of top down things that we're looking at. And by that I mean, you know, we'll look at, okay, is this portfolio properly diversified across multiple dimensions? You know, are there a lot of companies? There's not. We don't want concentrated deals. You know, generally speaking we don't want to be too focused on a sector or strategy. So we'll look at that and that's very simple in an initial review. Then we'll look at manager quality. So we'll look at the fund managers and just say, okay, well we can't predict how their funds are going to end up. But are they well regarded in their particular space? Do they have a long history of creating value? Have they operated in different economic cycles? Are they backed by other smart investors? It's just, you know, it's a good sign that someone is. If you see that your fellow investors are CPP and Harvard and other smart investors that you know can allocate to any funds on earth, let's say, we say, okay, it's a beautifully diversified portfolio, great quality managers. Now let's look under a layer deeper than that. The reality is when you're buying exposure to hundreds of companies, most companies are not that material to the fate of the deal. They're a fraction of a percent of your, of your overall investment. And you're not getting tremendous amounts of information. So those you're not worrying about, you're kind of relying on the law of large numbers, the bigger holdings within an overall portfolio which might represent 1 or 2% of the investment there. That's when we dig in and we try to understand, okay, how are these companies doing? Are they performing well? Are they on plan or you know, how much debt do they hold? You know, are they, what are their margins like, you know, is the manager of the fund expecting them to be telling us that they're going to try and sell them in the near term? So we try and get very smart on a subset of a portfolio, but the reality is you rely heavily on top down research and then assessment of the manager quality and then on the top 20 to 30% of the portfolio you're doing some bottom up work on the companies.

So you mentioned about, one of the benefits is you're coming in five years, five plus years in. So you skip, we talked about the J curve before. You essentially skip that lower part of the J where you know, the cash flows are negative. So how did that all, you know, the magic question it all, how does it all come together in terms of target returns or expected returns or historical experience either for yourself and your firm or just in general for the secondary funds market. Because presumably if I'm a private equity investor and I came in day one and I had to ride that J curve down and I'm there for 12 years, I'm probably expecting higher ultimate returns than if I come in in year five or six because there's a lot of, you know, you know what I mean? It just the law of investing would say I should get rewarded with higher returns for being in there for the extra five plus years and living through all that. On the flip side, the secondary Sounds like it's less risky than having that whole journey. So what are the ultimate results of these funds? And maybe, I'm sure you can't tell us to the, to the, to the decimal, but how have you done in your seven years?

Yeah, so I'll talk about secondaries in general, and you raised a great point. I think that primary fund investors, the people that came in on day one, generally speaking, because they've held it longer, they're going to have seen a much higher return on their investment. But if you look at that over the course of 10 to 15 years and look at the IRR or annual rate of return, you know, it may not be, it may or may not be as good as a secondary investor. But when a secondary investor comes in, often those portfolio companies are marked above their cost. So you're not going to see as much appreciation because they've already been marked up, say from one times cost initially to one and a half times. But you're still going to see some further appreciation, generally speaking, over the course of your ownership. And if you bought in at a discount, that's going to add to your returns as well. I think that it's important to think about risk because when you're coming in after the investments have been made, the overall portfolio may be written up. But I think what's most important is the weaker companies have been written down often or even written off and valued at zero. So you're coming in with your eyes wide open. You're not paying for the mistakes in the way that the original investors did. And if you look at secondary returns, it depends on the timescale you're looking at. But generally speaking, they've been as good as broader private equity and occasionally better. But the loss ratio or the number of secondary funds that have actually lost investor money is extremely low. You know, literally on one hand, one could name the funds that have actually returned less than the invested capital to their investors. So it's in that way much less risky than traditional private equity. I read a stat, and I really should look it up again because it's a great one. To quote something like 60% of venture capital funds return less than investors capital. They lose money. They may not return a zero, but they return, you know, if someone puts in a dollar, they get back less than a dollar. But the 40% that don't lose money, some of them return a massive amount. And so, you know, it's exciting on average because venture capital has done well over the, over the past few decades. But secondaries, I Think what people really like is that the band of outcomes is relatively tight yields, highly unlikely they lose money. It's also highly unlikely they make you a tremendous multiple of your investment. For our part, because we're focused on diversified secondaries and we often use the analogy of index investing, we really, we're not trying to pick winners. We're just trying to buy high quality, broad, diversified private equity. We've done quite well because the asset class has done well. So, you know, I won't maybe in this form share our precise track record, but, you know, private equity has dramatically outperformed public equity. And because we bought in at a discount, we've done that much better. We, we target making a team's return in our funds and, you know, hopefully market conditions are positive for the next five years. We do better than that. But that, that's what we're shooting for. And you know, historically we've managed to exceed that. But again, it's been in a very benign environment for private equity.

Perfect. So I guess there you have it. Private equity secondaries summarized the, the, the, the pluses and, and the characteristics. I love it. So just before we jump and thank you for your time very much, we have a question that we ask every guest. I didn't tell you this in advance. I always plan out the whole agenda and share it, but I always leave this one off. So our theme here is unlimited. You've seen some of our taglines, your wealth unlimited. Because, you know, we look at stuff like what you're doing and full disclosure, we actually have clients investing with Rob at overbay. So that's my regulatory requirement to say that because we can look at anything and our client portfolios, going back to what you were saying early on, do have private equity and do have other asset classes that may be the average investor out there may not, may not be investing in right now. So we're unlimited in what we can look at and see and do. And we like to help clients with anything they need on the financial side. So what I always like to ask our, our guests are, well, you know, the world is, it's your oyster, it's unlimited. If you weren't running overbay right now, you could do anything in the world that you wanted to do. What might you be doing if not running this firm?

Great question, and I wish I had been prepared, I would give you a better answer than I'm going to give you. But, you know, I think that I would like to work on, you know, some of the world's bigger problems to me what I think is a pressing issue, and. And really, we could probably, as a human race can be doing a better job is helping the poor overseas. You know, I think that it's. We have so much in the west, and just a little bit of our surplus can go so far in places like Africa and elsewhere. So that's where. Yeah, that's where I'd focus my time if I had more time. But in the interim, I just have to find good charities to support, so.

Right, good. That's a beautiful answer. Amazing. All right, Rob, well, thank you very, very much. Appreciate your time today. A unique asset class, different than what many folks have heard, different than what many folks are investing in. We're excited that we get to look at these sorts of investments and actually allocate some client funds to these interesting opportunities where appropriate for each client, of course. So I thank you very much and wish you all the best.

Thanks very much, Brian.

Okay.

The unlimited podcast is hosted and produced by Brian Ginsler and is edited and mixed by myself, David McMillan. This podcast is not to be taken as investment advice. If you like what you heard, don't forget to rate the podcast and follow us on Social medianslerwealth. Thanks for listening and see you next time.

Sam.