Featuring:

Paul Vittone, Head of Alternative Investments, BNY Advisors and BNY Wealth

Joanna Berg, Senior Alternative Investments Strategist, BNY Advisors

Arjun Bains, Portfolio Manager and Head of Secondaries, BNY Advisors

[00:00:01] VO: What do you want your wealth to do for you? Welcome to Your Active Wealth from BNY Wealth, where we offer insights that can help support the life you want to live and the legacy you wish to create. We tackle timely topics through the lens of the five strategies that comprise our Active Wealth framework: Invest, Protect, Manage, Borrow and Spend, and provide guidance on navigating the unpredictable to help you build and sustain wealth.

[00:00:31] Paul: Hi, I'm Paul Vittone, head of alternative investments, and I'll be the host of today's episode discussing current investment opportunities in the private markets. Welcome back to Your Active Wealth. I'm here with two members of the alternative investments team, Senior Alternative Investments Strategist Joanna Berg and Portfolio Manager and Head of Secondaries Arjun Bains. We're going to discuss the evolving investment landscape and what we believe are some of the unique opportunities in private market investing in 2025. But before we dive in, Joanna and Arjun, could you each take a moment to share a bit about your backgrounds and your current roles with BNY?

[00:01:11] Joanna: Absolutely. Great to be here, Paul. I've been in the alternative investments industry for over 20 years across investments as well as sales functions. I joined the bank five years ago from Morgan Stanley, and I currently lead the alternative investment strategy here for both our Wealth as well as our institutional business.

[00:01:32] Arjun: Thanks, Paul. I'm on the private equity team at BNY and today spend most of my time focusing on sourcing and executing investments across secondaries and co-investments for our fund of funds and our larger client accounts. Before BNY, I was with an independent private equity fund manager also deploying capital into similar types of private equity investments.

[00:01:54] Paul: Well, thank you both for joining me today. Before we jump in, let me provide some background for context. For nearly two years, the high-interest rate environment has challenged private market investments. Mergers and acquisitions activity (M&A) were more expensive to execute. Public markets remained uncooperative. The number of IPOs was significantly below historical averages. There were only 71 IPOs in 2022 and 108 IPOs in 2023, both of which are well below the average of roughly 200 IPOs per year over the prior decade. And this extended the average holding period for private equity-backed investments to roughly eight years, which is up from five years or so again over the prior decade. And the lack of exits resulted in a liquidity drought for investors and led to fundraising challenges for a large majority of private equity managers. But beginning in 2024, we saw a meaningful shift where the Fed cut interest rates three times in the second half of the year, taking rates from 5.5% to 4.5%. And the Fed hinted that there could be more rate cuts in 2025, albeit at perhaps a more measured pace. So that shift helped drive increased liquidity in private equity portfolios. Industry data showed a roughly 20% increase in M&A activity in Q4 compared to Q1 of 2024. And the number of IPOs in 2024 grew to 146, still below the long-term averages, but a marked improvement over the prior two years. So based on these factors, we believe the pendulum has swung and 2025 will see a continued boost in activity. The combination of lower rates, potential deregulation from the new administration, a continued innovation cycle, particularly in tech and the AI space, which we'll talk about. Those things should all drive M&A and drive IPO activity back to more normal levels. And that should be pretty exciting news for investors, especially those who can tolerate illiquidity, take advantage of the growth and the performance that's available in the private markets. Joanna, is that consistent with how you see it?

[00:04:22] Joanna: Absolutely. It's really been exciting news for sure, especially given the recent trends that we've seen within the private space, as we continue to see the push towards increasing allocations to private assets as they've become just an increasingly important part of the investable universe. 

[00:04:43] Paul: Great. Thank you. So private market investing, we all know, is a long-term asset class and we don't try to time the market. But today I do want to discuss why now could be a particularly attractive entry point into certain segments of the private markets, private credit, secondaries, lower middle market, private equity and venture capital just to pick a few. So, I'm going to ask Arjun and Joanna to help us explore some of these areas in greater detail.

[00:05:14] Arjun:  Definitely, private assets are more exciting than ever and there's a lot to break down.

[00:05:20] Paul: Joanna, I'd like to start with private credit, which has become an important source of lending since the Global Financial Crisis. I would expect private credit to typically perform well in a higher interest rate environment. But now that we see rates declining, do you still have conviction in private credit as an asset class?

[00:05:41] Joanna: Absolutely. And this is a question that we continue to get from our investors. You know, private credit or essentially loans from non-bank lenders to private companies, is one of our high-conviction ideas. We consider private credit to be an all-weather strategy, as it really has demonstrated strong outperformance versus public debt in all economic and interest rate environments over the last two decades. On a risk-adjusted basis, private credit has delivered an attractive premium over public debt, producing a higher yield and doing that on a consistent basis and really offering a great complement to our clients’ public debt portfolios. And additionally, there are many secular themes and sort of structural changes that we're seeing in the debt markets that we believe will continue to provide really strong tailwinds for the strategy.

[00:06:42] Paul: So, let's stay on that for a minute. The structural changes. Tell us a little bit about the evolution of the private credit market.

[00:06:51] Joanna: Private credit has really started to take hold in the early 2000s when we began to see the great bank consolidation. After the Global Financial Crisis is when we really saw the asset class take off, as we saw an increase in regulations requiring banks to hold less risky capital on their books and further taking more traditional lenders out of the middle market lending sector and paving the way for private lenders to step in. And then more recently, the regional banking crisis once again accelerated the bank disintermediation. Again, these banks are the primary lenders to the middle market companies. So, we've seen this secular shift in the credit markets that really has opened up the private lending opportunity. And these are changes that we believe are here to stay.

[00:07:46] Paul: So, banks, big and small, used to provide loans to private companies and now they're no longer doing that. And private fund managers, alternative asset managers are doing that instead. Is that right?

[00:08:02] Joanna: Exactly. These loans are bilateral. They're customized to the needs of the borrower. And there's a high level of due diligence done by the lender. Oftentimes the companies taking their loans are, for example, in some kind of a transition or a spin out. And thus, it may be considered too complex for standard lending procedures that the banks follow. These loans provide a premium in terms of the current income and also provide incremental returns from the additional fees that we generally do not see in the public credit markets. Private loans also generally only involve one or two lenders. And middle market companies really favor the privacy of such structures in order to remain competitive in the marketplace. You know, also the lenders, which are the asset managers, often have their own capital committed to these funds. And this is really standard practice in the private markets. So, interests are more aligned than what you typically see in traditional bank lending. While it may sound complex, private credit is really just credit extended by entities other than banks through private transactions.

[00:9:19] Paul: Got it. So sometimes this is just lending for working capital for private companies. And I imagine sometimes it's to provide financing for leveraged buyouts that private equity fund managers are engaging in. Are there other use cases for private credit? Or maybe to ask it differently, are there other areas within private credit that are attractive or well positioned, given the sort of the changes in the environment you just described?

[00:9:55] Joanna: Over the last few years, with rates rising, we've seen the spotlight shine on the direct lending component of private credit, which really is the largest sector of private credit. And direct lending is really loans generally comprised of floating rates with a healthy floor so the current income on these loans has been floating with the increase in rates. We've seen private lending return low teens to investors, which really generates a premium of about 2-3% annually over public equivalents. And these are generally considered riskier debt, such as high yield or levered loans. Additionally, it's worth mentioning that in the past, the defaults in the private lending marketplace have been lower and recoveries on those loans have been higher.  

[00:10:47] Paul: So, Joanna, a 2-3% premium, this is pretty attractive. Is that sustainable, particularly if we see rates decline or at least stabilize?

[00:11:02] Joanna: That's a great question, Paul. This premium has been evident not just in rising rates, but also in a low-rate environment. You know, when we look back at the last two decades, we've been in a low-interest rate environment. But this has also been a period during which private credit has outperformed public debt, and on a consistent basis. So even if rates stabilized, we continue to believe this remains an attractive strategy due to the secular tailwinds that we've talked about, as well as the consistency in income generation that this asset class has delivered over time.

[00:11:40] Paul: So beyond direct lending, are there other areas within private credit that are interesting or exciting to you or potentially untapped?

[00:11:51] Joanna: Absolutely. One area that we're particularly excited about is asset-backed lending. This area also involves private loans, but instead of being traditional corporate loans backed by the enterprise value of the business, these loans are backed by some cash flowing asset. So, this could be equipment loans, health care or music royalty backed loans, real estate or mortgage loans, consumer loans, aircraft loans. Right. The list can go on and on. And what makes this unique is the size of the space, which is significantly larger than what we see in traditional corporate lending.

[00:12:30] Paul: So, asset-backed lending is a larger market but hasn't been tapped.

[00:12:36] Joanna: Exactly, Paul. Despite its size, it's still relatively untapped compared to corporate lending. And that's largely due to its perceived higher complexity. Another key point is that these asset-backed loans have historically been uncorrelated to corporate loans. And that's really because they're generally bankruptcy remote, because there is that lien on an asset in these loans. And, also, they're amortized over time, right. And that means that principal is paid down throughout the life of the loan, which means that they de-risk throughout their duration. And this is, you know, compared to corporate loans that generally have bullet payments at maturity.

[00:13:20] Paul: It seems like there are always creative ways to access value in the private markets. And, you know, in particular, the way you described the asset-back lending as a complement to more traditional private credit strategies is a great example. I think secondaries, private equity secondaries are another example of a creative way to access value in the private markets. So, I want to I want to bring Arjun into the conversation here. Arjun, tell us about private equity secondaries and why they're becoming an important part of an overall private equity allocation and essentially the private equity landscape in general.

[00:14:03] Arjun: Well, Paul, secondaries in private markets simply refer to transactions where an investor buys an existing fund position or asset from another private investor known as a limited partner or LP. These transactions can typically be structured in a lot of different ways so that they meet the needs of the stakeholders involved. But the core objective ultimately is just to provide liquidity to the limited partner or equity holder invested in the private market asset. So, investing in a secondaries fund means you're investing in a fund that is deploying capital into these types of transactions.

[00:14:40] Paul: So ultimately, an investor, a secondaries investor, ends up owning interests in a private equity fund or indirectly owning equity in private companies, just like traditional private equity investing. What makes this so unique or attractive? As opposed to just doing a traditional, you know, private equity investment where of a fund manager raises a new fund and you make a commitment to the fund at the beginning of the vehicle.

[00:15:17] Arjun: Yeah, so I'd say it's attractive for a lot of different reasons. They're attractive because they provide really good diversification across vintage years, which refers to the year the fund begins investing capital, diversification across geographies and also underlying strategies such as venture, buyout, growth. They also provide access to the underlying assets at discounted prices, and they're often a lower duration private market investment. So, investors typically will see distributions far earlier in the fund life rather than waiting until years 5-10, as you would with a traditional private equity fund commitment.

[00:15:56] Paul: Got it. So just to reiterate there that you get discounted entry prices, you get good diversification, and you get shorter lockup periods before getting liquidity. That, to me, goes a long way to explaining why they're there gaining traction in recent years. What are the other factors at play structurally in the secondary market?

[00:16:24] Arjun: Yes, I think there is a little more to it, especially in today's market. So, for instance, we've seen a really weak distribution environment in private equity over the last few years, which you described earlier. And as exit activity slowed meaningfully, there's become a real focus on secondary markets to provide liquidity. To give you some context, buyout fund distributions as a percentage of their net asset value or equity value fell between 2021 and 2023 from over 35% following the market peak in 2021 to around 10% in 2023. And so, secondaries provide investors a way to manage that distribution level proactively on their own, especially when natural exit activity is lower.

[00:17:12] Paul: That's quite a drop, obviously. So, the way you're describing it, I think secondaries become a way for investors to essentially rebalance their portfolios, which, you know, was always a challenge with traditional private equity investing. Used to be that investors only sold in secondary transactions when they were desperate for liquidity. But now it sounds like it's becoming a more common practice.

[00:17:41] Arjun: Yeah, I'd say they've become pretty commonplace in today's market. But I also want to take a further step back just to put the current environment into context with respect to the rapid growth. So currently there are around 28,000 companies sitting in buyout funds valued at around $3.2 trillion and a near 50% share of those companies have been held for over four years. Then the amount of secondary capital in the marketplace is also pretty limited. And this creates a supply and demand imbalance between those wanting liquidity and the available capital of buyers. And the overhang of this resulted in a bit of a perfect storm to support an active secondary market. And that's led to an attractive pricing dynamic where assets can trade at a discount, and you can generate a healthy return in a secondary trade. During the last few years of weaker distribution activity. Secondary transaction volume scaled up to around $160 billion as of last year, which is up from $108 billion in 2022. So, I'd say secondaries are pretty attractive asset class right now.

[00:18:51] Paul: Thank you for that. I'm sure our listeners will find that fascinating. But I want to ask you a question similar to what I asked Joanna earlier. If we're in an environment where interest rates are declining or at least stabilizing, and as I suggested, potentially M&A activity and IPO activity increase so that traditional private equity investors are getting liquidity, does the attractiveness of the secondary market decline or evaporate?

[00:19:25] Arjun: Traditional exit activity increasing should certainly contribute. But I think there are other market forces at play which will support sustained growth and activity in the secondary market. To sum it up, I think that secondary markets should generally remain pretty attractive for a few different reasons. One, the sheer number of companies trapped in old private equity funds, which I mentioned earlier. Two, the capital formation and access to the asset class are increasing rapidly as semi liquid fund structures have become very common and I think will be important in continuing to support an active secondary market. And the last point I'll just mention is that secondaries are now viewed to be another tool in the toolkit for general partners and limited partners.

[00:20:11] Paul: Thanks, Arjun. Yeah, I think as I said before, it seems like the private markets with the growth of secondaries now have more similarities to the public markets where you can essentially rebalance portfolios in private markets more easily now. Is that the right comparison to think about?

[00:20:31] Arjun: Yes, there's definitely similarities. For example, if my illiquid private equity fund interests could be sold today and I still can lock in a healthy return and receive that cash to quickly deploy elsewhere, I'd certainly take advantage of it the same way I would in my public equity portfolio. There's north of $13 trillion sitting in private markets assets. Considering that the percentage of annual turnover in that figure is less than 1.5%, you begin to quickly realize just how low private markets turnover is in comparison to the public markets. And I think that annual turnover percentage will scale to be a lot higher than 1.5% over time, especially as investors now want to be able to manage their exposures more actively each year and now have the ability to do so with a lot more ease. Everyone wants to be able to manage their portfolio, whether it's public or private, and secondaries unlock the ability to manage your portfolio actively on the private side.

[00:21:32] Paul: Thanks, Arjun. I think it's interesting that that these newer sectors we've been discussing private credit, asset-backed lending, private equity secondaries. Very different in terms of the underlying investment, but they have some commonalities right there in particular. You know, they're all weather and they're very complementary to traditional private equity, which we happen to remain quite bullish about.

[00:22:05] Joanna: So, Paul, I'd love to chime in on your last comment there. You know, the interest rate trends that you mentioned earlier should be quite favorable for M&A and exits for existing PE portfolio companies. So, what would you say that does for new investments in traditional private equity?

[00:22:26] Paul: Yeah. That's interesting. Joanna, thank you. We haven't really talked about traditional PE yet. But I think that one thing that's been overlooked is how good the entry valuation environment has been over the last couple of years, that, you know, the flip side of the lack of liquidity is that we've had a pretty good time for investors to put money to work. I think we might look back at 2023 and 2024 as pretty strong vintage years for those investors that did find ways to continue to invest. But I don't think interest rates are going to drop so precipitously as to fuel a big spike in entry prices. Right. I'm rather I'm sort of thinking about entering a more normalized environment. We're not headed back to a zero-interest rate environment, right, where it's easy for all managers to generate returns essentially by, you know, sort of juicing their returns through the use of leverage. But when interest rates normalize, right, there's often more separation between the skilled private equity managers and the less skilled. Managers that really have operational skills in the middle market can create a lot of value by helping their companies grow and that can lead to outperformance. And so, in the environment that I think we're entering, it puts a real premium on manager selection. And then if, you know, if you sort of think about it on the venture capital side, I think interest rates are much less of a factor. Right. Instead, innovation cycles are more important than market or interest rate cycles. Right. Debt is used pretty sparingly in the start-up world. So, it's the innovation cycle that really matters.

[00:24:28] Joanna: Yeah, and that is such an important point and so interesting about this AI revolution that I think we could talk about for hours. But if we can go back to the more traditional private equity side. So, for those private equity investors, are there particular areas where private equity managers are focusing their efforts right now?

[00:24:49] Paul: Yeah. I mentioned AI, most of the activity there is in the venture capital side of the business. But traditional PE unlocks new sectors from time to time. You know, we've seen it in the past with software and health care for example. But I think one growing area of interest that we've been following pretty closely in traditional PE is around professional sports. The sports industry has been kind of off limits for private equity but has recently become a viable opportunity with investments in sports leagues, sports teams and franchises and then all of the related entertainment and media and hospitality businesses that go alongside sports. I think most of our listeners have probably read or heard about the NFL recently opening the door, passing a rule to allow certain private equity funds to be minority investors in NFL teams. Other leagues have followed suit. So, I think sports investments is exciting.

[00:26:03] Joanna: That really seems like an intriguing investment for our clients to consider. You know, 2025 seems to be such an exciting time to allocate to private investments.

[00:26:13] Paul: Yeah, it does Joanna. It seems like 2025 will be a pretty exciting and potentially rewarding entry point for private assets across a number of sectors, some of which we talked about today, at different entry points in the ownership structures. So, whether it's through primary investments or secondary investments as well as different points on the cap chart, whether it's through equity investments or debt investments. So, I think for our Wealth clients, we've been long-time advocates for the inclusion of private markets as a diversifier and perhaps more importantly, as a source of alpha within our portfolios. And I think 2025 should be no different. So, Joanna and Arjun, I want to thank you for joining me today and for your great insights. To learn more about these views, I encourage our listeners to read our 2025 Outlook, or to reach out to your BNY Wealth representative. Thanks for joining and we hope to see you on our next episode of Your Active Wealth.

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