Q&A: Pantheon’s McCrary Says Private Equity Market ‘Robust’

Dec 17 2014 | 9:32am ET

Dennis McCrary is a partner at Pantheon, a private equity firm with $32.2 billion in assets under management; 197 employees; and investments in Europe, the U.S., Asia and Latin America. Founded in 1982, the firm now manages regional primary investments, global secondary and infrastructure investments, and customized separate accounts on behalf of more than 400 institutional investors. In 2010, the firm was acquired by global asset manager Affiliated Managers Group and senior Pantheon employees. McCrary spoke to FINalternatives' Mary Campbell recently about private equity opportunities, manager selection and the burgeoning secondaries market.

How would you characterize the current valuation environment?

The valuation environment is quite robust right now,  driven in part by the liquidity in the markets and aggressive leveraged lending, and that influences and affects all of the opportunity set across the globe, really, but particularly in the United States and Europe.

Where do you currently see opportunity?

Where we are finding the best opportunities...on the primary side and on the co-investment side, is with groups that have developed expertise in certain industries...

When we look to make fund investments on the primary side, we're looking to make sure that the firm has those skill sets that will allow them to be a bit more specialized and experienced in certain industry sectors and also have the capability to create value at the operational level....That can come in the form of having operating professionals who are actually partners in the firm. It can come by having, if you will, a stable of relationships where they can bring operating professionals in to work there. And also...it can come just by having investment professionals who have developed over their careers, whether it's been directly in operations, in consulting or just through being experienced private equity professionals, the skill sets necessary to oversee a company, govern a company, pick the right management teams and make appropriate strategic decisions going forward.

Can those skill sets cut across industries and sectors?

In certain industries, for example, healthcare, where knowledge of the regulations is important or if you're in the medical device space and knowledge of reimbursement for example, is important, that's not necessarily a skill set that's transferable into say, financial services.

And obviously, energy is a very specialized area—from an engineering perspective, from a geology perspective, for example—in terms of the economics of the markets. Energy is a sector where we prefer to be investing with specialists.

None of this suggests there can't be successful generalist private equity firms because certainly there are but I think, over time, as more groups become specialized, that becomes more of a competitive advantage and it puts more pressure on groups to have areas of expertise—it may be two or three as opposed to just one—but they do need to develop, in my view, level of specialization and focus.

Does Pantheon have areas in which it specializes?

We're looking for groups that have the expertise that I've just described. For example, we do have a number of commitments to energy-related funds and we have an investment professional within our firm who specializes in the energy sector.

As another example, if we're going to invest in a distressed-oriented fund, whether it's equity or debt, we have a professional who has developed an expertise in evaluating groups and funds in that market. But we're not so specialized that we only focus in two or three sectors; Yes, we're looking for a broad variety of managers that can focus in different areas, as I have highlighted, for example, energy, healthcare, financial services. But, we also invest with a manager that invests only in the food industry; we have managers that focus on technology (at all stages; VC, growth, and buyout)...This is primarily in the U.S., because of the size and the homogeneity of the market, it is more efficient and easier to develop an expertise in an industry that you can then scale and utilize; whereas, in Europe...because of the differences across the countries in languages and regulations, for example, it's more difficult to  only invest in that sector across a more diversified investment landscape. I think specialization is likely to develop more in Europe, but for now we see it more in the U.S.

The operational strengths of a private equity firm can be utilized whether they're specialized in one industry or a generalist. Having somebody with operational experience, who's actually been a CEO or a manager in a business is naturally very helpful when working with portfolio companies and management teams.

Regionally speaking, are you seeing more opportunities in Europe or the United States?

It's definitely a mix—and I don't want to leave out Asia. We're investing actively in all three markets and...in other emerging markets as well, including Latin America. But to answer that question, I think the U.S. continues to be a steady economy and...in spite of the fact that the valuations are pretty high, we believe it's still and attractive  environment in which to invest.

There are some interesting opportunities in Europe but you have to look at it differently across different countries. And also... in Europe there is a good deal of private equity capital there and so for medium- to larger-sized companies that are pan-European, that are very strong operators, the valuations are quite high right now because there is strong interest and a significant amount of private equity capital available to make those investments, and also a relatively robust debt market. That's one thing that you can't ignore when you talk about private equity today; the debt markets are quite strong and so that's driving up valuations as well.

So we do see some interesting opportunities in Europe and we continue to do both primary, secondary and co-investing in Europe but there's nothing that I would say that's overly thematic about it... rather just a continuing opportunity set that does provide for some good businesses, which we can invest in.

What is happening in Latin America?

There are a few countries, for example, Colombia, which are growing pretty rapidly and so we have an office there; we've invested in a few private equity funds, we also have done co-investments there...Obviously you have to be selective, but we think that in the long run—and that's why we're there, because we believe it's a long-term investment on our part—in the long run, you'll see Latin America continuing to grow. It has a very young and vibrant and reasonably well-educated population in a number of countries...

We see it also as an area potentially for raising capital because...the pension plans in Latin America are actually in a positive curve in terms of adding capital and paying less out because of the young composition of the workforce there, whereas in the United States for example, that isn't the case for defined benefit plans, it's going the other way. So we're there mainly as an investment firm but there are opportunities to raise capital in Latin America.

Do you choose areas in which you wish to invest and then seek out managers or do you find managers that spark your interest in particular areas?

It goes both ways, actually. We may conduct analysis and decide, 'This is an area that we want to be invested in'—a particular industry or sector perhaps—and it may take months or even a couple of years to meet with all the managers that we think could be effective and then decide which ones we'd like to invest with. And then, this business works on a  three-year, four-year, five-year fundraising cycle so we might identify a group that we really like but then we'll have to wait a couple of years to be able to commit to them unless we're able to buy an older fund position in the secondaries market, which does happen on occasion.

Then there can be cases where someone will come to us with a particular strategy that maybe we're not as familiar with and, if we find it interesting, we'll use that as a basis to conduct our own analysis, explore firms that are in a similar space and then decide which of those, or it could be more than one,...we think are going to be most effective in that market.

You mentioned the secondary market, how important is it to your business?

The estimates are that the market for this year will be somewhere around $30 to $35 billion in terms of transactions but I think that's just the known sources and there are a lot of secondary deals that happen that people don't know about...It's a relatively private market, obviously, and in a lot of ways people just don't know who all the players are and there's an increasing number of sovereign wealth funds and family offices and other investors that are coming into the private equity market in general, but which are likely to also be participants in the secondary market.

We're a very active player, a week does not go by that we don't review least one new deal and we invest hundreds of millions in the secondary market each year and it's a very active market. It used to be—and when I say 'used to be,' say, 10 years ago to five years ago—that investors who wanted to sell in the secondary market did so relatively quietly and they were doing it in many cases  for regulatory reasons, or where they changed strategies and that's where you saw secondary trades. That continues to be the case in certain markets and geographies but now, more and more, investors are using the secondary market to balance or adjust  their portfolios, or to sell off two or three different fund names instead of a big portfolio. There are obviously still very large portfolios being traded for strategic or regulatory reasons but it's become a much more active market, it's becoming more efficient, it's often intermediated—it used to be that there were more...seller-to-buyer transactions taking place, and now...you see intermediaries directing the process...

All these different participants and opportunities make for an interesting and dynamic market in my view. Certainly the big names, the big mega-funds trade very often—you see that a lot—and then you see investors, and we would be included in this, trying to do more complex transactions where it's maybe more directly negotiated, and create more value.

Our overall approach is pretty systematic. We maintain a comprehensive list of funds we own, funds we are watching, funds we like and we update our pricing regularly. This helps us identify opportunities we think might be undervalued and which we might be interested in buying. In our view, the more you know about a fund, the better your participation can be in the secondary market. We aim to be an informed participant in the secondary market, and our relationships globally with hundreds of PE firms enables us to be well informed.

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