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Stewart: Welcome to another edition of the InsuranceAUM.com podcast. My name Stewart Foley. I'll be your host. Today's topic you're really going to like. It's private credit secondaries, and we're joined by John Bohill, partner, private debt, at the StepStone Group. John, thanks for taking the time. Thanks for being on today. I look forward to this.
John: Stewart, it's great to be here. I've enjoyed your podcast, so it's just great to be here and doing one myself.
Stewart: Yeah, this is good. It's very good. And I want to start it off the way we always do, which is, where did you grow up - what town? What was your first job? Not the fancy one. And what makes insurance asset management so cool?
John: Well, I grew up in Terenure, in Dublin. I'm sure you can tell by my dulcet tones, my accent. Then I'm an Irish man by birth. I grew up in Terenure. As I said, I went to a rugby oriented school. I think there, if anything, I learned, I think the value of team sports and participating in teams. It's the one thing I hold dear to this day. My first job, I think that everybody as they grow up, they should work in a restaurant. And that ability to deal with the public, to deal with the chaotic, to chase down people who don't want to pay their bills and to just work with very temperamental chefs is probably the best experience I've ever had. I think.
Stewart: That's a perfect set of experiences for the asset management industry.
John: Oh, indeed.
Stewart: It's absolutely perfect. And what makes insurance investment management cool?
John: Oh, listen, I think I probably always had an affinity for numbers. I think I always had an affinity for... In our end of the market, I think private credit and private markets in general, you're really dealing with people one-on-one. These are not broad discussions happening in the wider stratosphere of investing. So for me, that bilateral discussion with counterparties was always very important and I think that's one of the key differentiators, I suppose, when you think between public and private opportunities. Therefore, everything at some level is somewhat idiosyncratic. And I think that's what appeals to me and that's what kind of gets me excited.
Stewart: That's so cool. And so I want to get into it here. I hear a lot of chatter about private credit secondaries and it just seems like this is an area where insurance companies can find real value. And also I think a healthy secondary market helps to increase initial allocations, right? If people feel like they've got a way to get back out. So why is everybody talking about private credit secondaries right now? If you can just give us the lay of the land before we go on.
John: Absolutely. Well look, I think there exists the private secondary market because there exists a primary market. It's so important in this environment, I think, that people have gained a comfort with private debt. I've listened to your podcast and some of the more recent ones are particularly indicative where everyone is more comfortable with private debt at this stage of its evolution. I think 10 years ago, not so much. I think the wider investment community thought of it as a distress space or something that could activate during certain times in the cycle. I think now it's reached a level of maturity and distinction that it's part of an asset allocation. And as I said before, if there exists a primary market, at some point somebody's going to suggest a secondary market and that's what's happened. I also think in tandem private equity secondaries have been around for 20, 30 years.
And I think being lazy individuals that we are, we just extrapolate forward and decide to take a market into a new direction, and that's identifying the debt part of the equation. I think the other reason, which is more recent and perhaps more topical for your listeners is the dislocation that we've seen since 2022 after about 10 years of zero surprises. I mean total predictability of low interest rates, very benign credit environment. Now there's uncertainty, there's stress, there's an element of subjectivity. And as I always say, if the subjectivity, there's a market, because we have a different view on the value of that underlying value. But it's certainly topical. It's certainly where all the discussion seems to be happening at the moment, and that's where we are.
Stewart: And where is the volume coming from?
John: This is the key question. Prior to 2022, there was no subjectivity in the market. Everyone expected those buyers and sellers to be transacting at the same level. Now I think there's a disconnect. I think there's a real difference of opinion. The liquid markets went south in 2022. You saw liquid equity, liquid debt, and taking big drawdowns and I think investment owners, so insurance companies but also sovereign wealth funds and other investors, they looked at the private debt parts of their allocation and they realized actually these parts of the portfolio are holding up really well. They're still yielding.
And so if I take a 15% or 20% markdown on my liquid assets, my liquid equity portfolio, I'm locking in that loss and I won't be able to capture that rebound. Whereas if I take a 10% discount on something that's performing at positive six, actually something that used to be considered illiquid is perhaps more transactable. And that's where the seller volume came from. It wasn't so much a denominator effect or portfolio rebalancing as a kind of tactical decision by those asset owners to temporarily come out of the market. And so we saw a certain amount of flow becoming available in the secondary market, and that's something that certainly StepStone executed on and targeted.
Stewart: And I guess the question is once a seller, always a seller, is the market liquid enough to make tactical moves and reposition if someone wants to change their exposure as opposed to simply reduce their exposure?
John: One of the things you've identified it there I think that we've seen is when selling in the secondary market, you are not making a permanent decision. It's often about tactical decisions to match liabilities or to meet obligations on a short-term basis or just make your portfolio look a little bit coherent. I think one of the things that private debt has done really well over the last 10 years of its evolution is become much more efficient at optimizing things like fees and costs and cash drag so that if investors wish to step away from the market or take the foot off the pedal for a little while, they can reengage really quickly. And there's a lot of ways of doing that. They can sell via secondaries, they can buy via secondaries, they can also ramp up their primary portfolios outside of traditional fund models which are more efficient.
And I think one of the areas that you're really seeing that in is the insurance space. In the insurance space, probably more so than a lot of other types of investors. There's obviously a lot of focus on fees and costs. The efficiency of making a commitment decision and then actually getting invested are two different things. And one of the things we really emphasize is that efficient capital deployment when they decide to reengage. So I think those techniques have been fine-tuned over the last 10 years and we're at a position now where investors can make those tactical decisions quite efficiently.
Stewart: That's really helpful. Can you talk a little bit about the supply and demand dynamics with the emergence of private debt secondaries? Just give us a little bit of color on how the two sides of that market are shaping up.
John: So as I said before, I think the asset owners are quite comfortable with the asset class and through... Or let's say since the global financial crisis, the development of private debt has enabled them to become comfortable, secure in those asset allocations. They've received year-on-year income. They've had some problematic years recently or some periods where there's a little bit more dislocation. And they can see, I think the continuing performance, there are certainly stresses, but we're talking about loss rates that may be creeping up a little bit, but not something that would jeopardize the entire space entirely. And so on a primary basis, funds have raised money of the private markets, asset classes... I think private debt has... If there are tailwinds, I think it has if not the most, maybe one of the most pressing tailwinds that's driving demand for primary funds. On the secondary side, as I said, nature abhors a vacuum and I suppose asset managers abhor an opportunity that isn't offering a new a UM opportunity.
So they've raised funds. Now the question we're always asked is are there too many private debt secondaries funds or is there too much capital chasing this likely demand? And the answer is hard to tell. It's certainly true that credit secondaries are difficult to predict. They're less predictable than the primary side of allocation. And that's why at StepStone, I guess we tend to co-mingle primary and secondary within the same entities, within our client entities. And that's to give them the efficiency of the primary activity and the predictability. I call it boring predictability because one thing's for sure, you don't want surprises in your private debt portfolio.
And then the secondary opportunities, periodically they'll come along... GP LEDs, LP LEDs. So GP LEDs being those transactions that are introduced by the managers themselves and tend to be portfolios in themselves. We tend to do a lot of those on a bilateral basis. And LP secondaries. These are transactions where they're typically are brokered, they would be fund units, so you're going into an existing fund. Those are periodic opportunities and certainly at StepStone we choose to put those together with our primary investing capability and that gives us that certainty of deployment that I talked about, which is really important. And as I said, particularly important for the insurance audience.
Stewart: Is this... I mean, in your mind, is this a temporary phenomenon? Is this going to have permanency? And I want to talk about how, if I'm a CIO at an insurance company, how do I learn more if I want to make an implementation or make an allocation... What are the ways I can do that?
John: I don't think it's a temporary phenomenon. I think it's part of the ongoing narrative of the private debt asset class in growth and maturity and sophistication. I think we're learning lessons about how it will be a permanent phenomenon in strategic asset allocations. I think for a CIO, the really important messages that I think there are learning is that in this, as I said by conception, illiquid asset class, I think there are ways of exiting in a non-impairing way throughout the cycle. And we've seen that in the last two years.
So if they're thinking about increasing exposure to private debt as an asset class in general, as a backstop, I think there is a liquidity tool and a portfolio tempering tool through secondaries, which will endure. There is this growing dry powder pool in private debt secondaries, both generalists like we are and dedicated credit secondaries funds to allow for that backstop. And I think that underpins its ongoing value in the toolkit of private markets investing. And I think one of your earlier contributors talked about the withdrawal of the differences between public and private investing. I think you're going to see more of that. I fully agree. I think people are looking at credit at an underlying level, at an asset level, at an investment style level, secondaries, primaries, and there is a co-mingling there as well. So I see it really with the backdrop of the ongoing narrative of the evolution of private markets and private debts specifically.
Stewart: Am I thinking about this correctly... If I've got a private debt portfolio and I'm playing... I'm mainly in the primary market, do I need to be thinking about a secondary market allocation differently? Because what I'm hearing you say that at StepStone, you're putting them together with your primary activity, right? Which makes sense to me because if I ran an equity portfolio, whether I bought it on the primary market or on the secondary market, it's still in my portfolio, right? And so I can see how the secondary, where it's being sourced, that the secondary market could be seen as just a second or an additional form of deal flow. Am I thinking about that in the right way?
John: I mean, I think you're hitting the nail on the head there, Stewart. I think that's exactly how you should be thinking about it. We think about it in terms of relative value and relative efficiency. So for one unit... For $1 of risk on the primary market, what is my return? For $1 of risk on the secondary market what is my return? There are overlaying issues there like the inherent credit risk and what is the duration of the investment? What is the term of the investment? But it really is a relative value assessment and I think that's what should be the guiding light, the northern star for this kind of investing. Otherwise, you get adverse bias. Well, this is my personal view, and you would say... Well, you would say that's StepStone because you choose to invest in this way, but if I have a credit secondaries fund, I am predestined to invest only in secondaries.
Does that create a bias towards chasing the deal? Does that create a transaction risk or a return risk? From an investor point of view? You could argue yes. And what I would rather do is look at that underlying credit portfolio and assess it for return and risk on an idiosyncratic basis. And look and see out of all the opportunities that we see at StepStone across the entire credit landscape, if it stacks up. If the answer is yes, then it goes into our credit portfolios. If the answer is no, well then it's a deal kill. And that's I think how it should be.
Stewart: Yeah, and I'm hearing... I think there are others who are taking this approach, which is... And maybe I don't want to put words in your mouth here at all, so this is me, like my interpretation of it, right? But it's like let's not worry about whether it's private or public or just what, let's look at the credit and then where it came from, whether it's primary or secondary or whether it whatever... Public or private. That's really shouldn't be the driving force. I mean, we had someone on that was talking about private ABS and it's like private ABS and public ABS, it's the same collateral. It just depends on how it's packaged and through what means of distribution. But, really, you need to be focused on the collateral. And I think you're making a point that you really need to be focused on the credit and then how you got it should be a secondary consideration.
John: I think one of the lessons from the financial crisis is that we got a little bit away from that collateral focus. There was a reduced understanding of where the collateral risk existed. And I think the more derivative exposure you take, the more you need to be focused on what's at the underlying driver of yield and value. And I think that's exactly the attitude we would take to this. We're always looking at a credit level, whether we're looking at a portfolio of 160 loans in a certain portfolio, or perhaps more so if you get a fund with 20 investments or a partly invested LP stake with 60% undrawn capital. That presents risks where you have to take a backward look a forward look, you have to take a look at the credit risk on the existing portfolio, but also the likely underwritings going forward.
And these are things that are intrinsic in those deals. Actually, this is where hopefully we can add some value because this is where we get to integrate all of the data we collect. And that's where some of that subjectivity gets to show its face because I get to say, well, look, we take a view in this way and you take the opposing view and we either transact or we don't. So ultimately the richness of that discussion really favors the participants, particularly those I would say with a decent grasp of the data.
Stewart: Yeah, I mean that's the situation where experience matters, right? I mean expertise in the ability to have those conversations and who to talk to and where to source the deals. I mean, are you seeing plenty of deal flow? Is there plenty? Are you seeing opportunities here? Can you talk a little bit about deal flow over the last, kind of, recent near term and what you see going forward?
John: I'd say 2022 was a good year for volume, particularly towards the end of last year. I think the deals that we've reviewed this year are probably 50% up on last year. I would say round numbers. So definitely there are a lot of deals. I think there are more participants on the buyer side, so I think it's more competitive. We're approaching a point where I think pricing is really... Is approaching a point of, I wouldn't say perfection, but certainly there's a growing awareness of that trade off with primary deployment. There's a reals of value assessment going on and some of the transactions that we've seen occur recently would be at a point where it would give you pause, certainly. I think that's probably good for the industry because sellers are getting a very good deal, I think, at the moment, and I think that will persist for a while. So there is deal flow, but we're not getting hung up on it or we're not certainly chasing deals.
Stewart: I have learned a bunch today, I really have, and I really appreciate you being on. I've got a couple of fun ones for you out the door. We introduce optionality into the equation and we have two questions you can take, either or both. Most of our guests take both. No pressure. What's the best piece of advice you've ever gotten? And who would you most like to have lunch with, alive or dead?
John: Best piece of advice. I think in my first, we call them the not proper jobs... This was my first job, so I worked for an investment bank in London straight out of college, and there's a great deal guy called Victor Basta... He was addressing us as an analyst class. And he said, you guys, these Oxbridge types and Ivy League types in the room... And they said, you guys, you think you're smart. Let me tell you now, you're never the smartest person in any room you're in. And I just think about that because we talked about the aims of this podcast and this great conversation you have going in insurance AUM and the idea of teaching... And I think teaching or participating is interactive. You're always learning. Even when you are in the teaching role, you're always learning. And so that was a really smart piece of advice, which I kind of talk about on an ongoing basis.
Maybe who would I like to have lunch with? My son and myself, we listen to a podcast called The Undercover Economist, Tim Hartford. It's a great podcast. It's about behavioral economics. About the decisions individuals make under pressure or maybe the lessons they could learn in acting in imperfect ways, in human ways. So Tim Hartford, living, and just given the week that's gone by and the wider world we're in terms of geopolitical risk and the statesman that he was, I'd love to have a conversation with Henry Kissinger.
Stewart: Yeah, that's interesting. I think I'm with you on that one.
John: What would he say about the various things going on in the world and how the US, but not just the US, has a role in defining the future for our children and their children?
Stewart: It's so true. And my daughter's 18 and I think about it all the time.
John: Exactly.
Stewart: So it's really a great point. I've learned a bunch today. We've been talking about private credit secondaries with John Bohill partner private debt at the StepStone Group. John, thanks for taking the time. Thanks for being on.
John: An absolute pleasure, Stewart.
Stewart: Thanks for listening. If you have ideas for podcasts, please shoot me a note at podcast@insuranceaum.com. Please rate us, like us, and review us on Apple Podcasts, Spotify, Google Play, Amazon, or wherever you listen to your favorite shows. My name's Stewart Foley and this is the insuranceaum.com Podcast.
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