Embed Size (px)
Citation preview
finish
&Performance
Portfolio
The 2004 Vintage, 10 Years Out IRRs & Bad Management Co-investment with Siguler Gu�, Cambridge Associates & StepStone
In-depth LP interviews with Performance EquityZurich Alternative Sovereign Investor Institute Ardian& Colombia’s second-largest pension
Q2 2014
Premium Content Exclusively for Privcap Subscribers / www.privcap.com
PRIVCAP / SPECIAL REPORTS
On Privcap.c0m
Videos in This Report
What the Sovereign Wealth Funds WantSovereign Investor Institute’s Scott Kalb says the $6 trillion SWF sector wants more than returns from its GPs.
Tips for Selecting a Quality GP ManagerFrank Brenninkmeyer of Performance Equity on what his firm seeks in a GP manager and its history with GM’s pension group.
Creating a PE PortfolioOmar Rueda Galvis of Colombia’s ProtecciÓn talks about his group’s entry into the PE market, dealing with foreign and local GPs, and where their focus lies in 2014.
An Insurance Group Wagers on More PEFerdinand Seibert of Zurich Alternative Asset Management dis-cusses PE’s role in a portfolio, the effects of regulation, and how to differentiate GP operating skills.
Ardian Is the New AXA Private EquityVladimir Colas of Ardian describes the firm’s move to indepen-dence, its European middle-market roots, and its approach to primary and co-investing.
How’s the 2004 Vintage Looking?What do we know about the average performance of PE funds in the 2004 vintage? With experts from StepStone, Cambridge Associ-ates, and Siguler Guff.
Fund-Management Mistakes That Shave Off IRR Points“Deal guys” don’t always consider performance optimization of their fund, making mistakes that shave off IRR points. With experts from Cambridge Associates, StepStone, and Siguler Guff.
Adding Alpha Through Co-investingA deep dive into Siguler Guff’s co-investment platform—how it helped the firm add alpha to its portfolio. Experts from Cambridge Associates and StepStone weigh in.
COMING SOON on Privcap
This special report includes the following new video programs. Watch them at Privcap.comOn Camera
Colombia’s Growing Appetite for PEFrancisco Jose Arboleda of HarbourVest Partners talks about private equity in Colombia, and the growth of the industry and talent in the country.
PE’s Influences in ColombiaAlejandro Rodriguez of PineBridge Invest-ments speaks with Privcap about private equity’s impact in Colombia, the country’s pensions, and local and regional offices.
UPCOMING REPORTSQ2Co-investment Energy
Andrea Auerbach, Cambridge Associates
In Case You Missed It...
KKR and Its Capital Partners Suzanne Donohoe, who leads investor relations for KKR, describes the evolving needs of the firm’s institutional investors clients.
Must-see thought leadership from Privcap.com
On Privcap.com
About Privcap Special ReportsPrivcap Special Reports are exclusively for subscribers to Privcap, the definitive channel for thought leadership in
private capital. Each month Privcap focuses on a critical theme and produces a “bundle” of thought-leadership
content in multiple formats – a digital report, video interviews and panel discussions, and audio programs. We
capture the market intelligence of leading authorities, whose expertise forms the core of each report. Privcap
Special Reports help market participants better understand opportunities and practices in private capital, as well
as gain deep insights into the people with whom they may become long-term investment partners.
CFOs Navigate the Headwinds Scott Zimmerman of EY discusses the results of a survey of PE firm CFOs. Despite regulatory and business challenges, these team members are optimistic about the futures of their firms as they gear up for growth.
Forklift to the Future: KKR’s Investment in KION Johannes Huth of KKR describes the thesis behind the firm’s successful investment in KION, a German maker of forklifts and other industrial trucks.
From Defined Benefit to Defined Contribution The shift from defined-benefit to defined-contribution plans in the U.S. is inevitable—and it’s happening faster than expected, says George Pandaleon of Inland Institutional Capital Partners.
How Much Does a Fundraising Cost? Three PE leaders discuss how much a GP should expect to spend raising a fund. With Gene Wolfson of Catalyst Investors, Adam Blumenthal of Blue Wolf Capital Partners, and Mounir Guen of MVision.
Profits, Impact, and Energy Efficiency Carter Bales and former NY State first lady Silda Wall Spitzer discuss the investment strategy of their firm, NewWorld Capital Group, which backs companies fighting energy waste.
PRIVCAP SPECIAL REPORTS
05
PRIVCAP SPECIAL REPORTSPrivcap Media David Snow Co-founder and CEO Gill Torren Co-founder and President Matthew Malone Editorial Director
ContentAinslie Chandler Senior Journalist Andrea Heisinger Associate Editor Kathleen O’Donnell Media Coordinator Cameron Faulkner Media Coordinator
Design Cecilia Salama Design Coordinator
Contributors Tom Stein
Contacts
Editorial David Snow / [email protected] / 646.233.4558
Matthew Malone / [email protected] / 203.554.7261
Sponsorships & Sales Gill Torren / [email protected] / 646.233.4559
For subscriptions, please call 855-PRIVCAP or email [email protected]
Copyright © 2014 by Privcap LLC
Commentary The long-term view required of private equity inves-tors has its challenges and rewards, says Privcap CEO David Snow.
What Colombia’s Second-Largest LP Wants Omar Rueda Galvis of Colombia’s Proteccion discusses the genesis of their PE program and why they want to invest with fewer GPs.
PE Performance Panelists from Siguler Guff, Cambridge Associates, and StepStone Group discuss the latest private equity performance numbers.
◆Making Co-investment Work ◆Maximizing IRR ◆The 2004 Vintage Plus: Brazil Funds Gaining Strength
Four LPs Talk Portfolio Privcap contributing editor Tom Franco talks with thought leaders from the LP community about PE in the portfolio, and the future of the asset class.
◆Ardian’s Independence Day, with Vladimir Colas of Ardian ◆A Global Insurance Group’s Bet on PE, with Ferdinand Seibert of Zurich Alternative ◆Breaking Down GP Manager Selection, with Frank Brenninkmeyer of Performance Equity ◆What Sovereign Funds Want in a GP, with Scott Kalb of Sovereign Investor Institute
From the Archives Related content from Privcap.com
From Our Sponsors Thought leadership from our sponsor: Gen II
07
11
17
2 0 1 4
22
Interviews in this report have been edited for length and clarity.
21
In This Issue19
26
19
finish
07
11
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 5
PE PERFORMANCE AND PORTFOLIO / COMMENTARY
Market Analysis by CEO David Snow
Low-Frequency Trading
f the stock market has a millisecond prob-lem, private equity has a problem measured in decades.
Among its many revelations, Michael Lewis’ new book, “Flash Boys,” highlights the mind-bog-gling complexity of a mature, traded, technolo-gy-dependent asset class. The U. S. stock market has moved so far beyond its origins in human bar-tering that it now has been taken over by comput-ers that snatch value out of the market in between millisecond trade matches.
Compare this bewildering state of affairs to the less mature, less traded, and technologically underpen-etrated private equity market. People aren’t kid-ding when they say private equity is a long-term asset class. You could commit capital to a private equity fund, raise your kids and send them off to college before getting back the full value of your investment in cash. Perhaps this is as it should be—left to your own fickle decision-making over that roughly 15-year time horizon, you might have stopped investing and missed the prime buying opportunity, desperately sold your best assets in mid-recession, or blown the whole allocation at the top of the market.
Instead, you paid a GP to laboriously deploy the capital over a four-or five-year period, and then re-main long-term greedy in deciding when and how to exit those investments. Sell that struggling con-sumer business in 2010 just because LPs were com-plaining about needing liquidity? No way. Better to wait it out. That’s called control and optionality. If you need liquidity, sell off your stock portfolio.
In this special report on performance and portfo-lio management, one of the related measures we examine is DPI, or distributed-to-paid-in capi-tal. That’s the ratio between how many dollars
The private equity asset class is both blessed and challenged by its very long holding periods
you put into a private equity investment and how many you’ve gotten back. In this report, three ex-perts—Andrea Auerbach of Cambridge Associates, Mike Elio of StepStone, and Kevin Kester of Sigul-er Guff—examine the DPI of private equity funds launched in 2004. As of Cambridge’s last measure-ment date, the 2004 vintage funds have an average DPI of 1.02. That’s well behind typical distributions from funds entering their second decade. We can, perhaps, blame the lag on the Great Recession, dur-ing which exits were few. But as our gathered ex-perts point out, private equity fundraising rose all the way through 2008. Therefore, a huge amount of private equity’s hoped-for outperformance re-mains trapped in a collection of portfolio compa-nies of unprecedented aggregate size. As Elio puts it, “If all your gain is still tied up, we have so many assets to liquidate, it’s going to be difficult.”
Secondary “Flash Boys”It’s clear that new participants in the private eq-uity asset class, armed with decades of such per-formance data, should know what they’re signing up for—GP relationships that will span well be-yond the advertised 10-year life of the individu-al funds. Investors still concerned about liquidity should also note the increasing size and dexterity of the private equity secondaries market, in which opportunities to trade in and out of partnerships are not quite at “Flash Boys” levels, but are signif-icantly more technologically advanced than even five years ago.
Driving liquidity in the private equity market is the removal of what was one the main impediment to secondaries dealmaking: shame. GPs used to find it embarrassing when LPs wanted out of a fund. To-day, this request to trade is now widely accepted and, in many cases, welcomed as an opportunity to forge a relationship with a new investor.
Evidence exists that another psychological barrier to secondaries deal-doing is also fading—the stig-ma of NAV pricing. In the public market, partici-pants have so many varying views and goals that
IF THE STOCK MARKET HAS A MILLISECOND PROBLEM, PRIVATE EQUITY HAS A PROBLEM MEASURED IN DECADES. “ “
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 6
PE PERFORMANCE AND PORTFOLIO / COMMENTARY
a stock can find itself priced very differently over the course of an economic cycle. What’s the right price-to-earnings ratio for General Electric? It depends on facts specific to GE and the markets it serves, about which many smart people have different views.
In private equity secondaries land, by contrast, there has historically been a singular focus on pricing around NAV. As in, “Did you pay a pre-mium to NAV or a discount to NAV?” The more a market participant regards NAV as the “true” value of a partnership interest, the more like-ly they are to believe that buyers are winning if they scoop up a discount and sellers are win-ning if they command a premium. In lieu of more and better information, NAV pricing is the most important scoreboard. Countless sec-ondaries deals have fallen apart over NAV.
But the NAV is a number assigned by the GP to a collection of private portfolio companies that, while striving for fair value, can credi-bly vary widely based on the methodology and outlook of the team doing the valuation. The best secondaries investors take a view on un-derlying portfolio company valuations, not
fund-level NAV. Indeed, a recent study con-ducted by Pantheon’s Rudy Scarpa found that the performance of the firm’s secondaries pro-gram had little to do with the depth of discount paid for a bundle of fund interests. Scarpa ar-gues that buyers who focus solely on large dis-counts to NAV may be encouraging the wrong kind of deal skills.
Increasingly, technology is helping more PE market participants make better decisions around secondaries deals. Platforms that link portfolio data all the way up to limited partners and their advisors bring the asset class a smid-gen closer to the symmetry of information that the public market is supposed to provide (re-peat—supposed to).
It will be a long time before private equity’s inefficiencies are arbitraged in milliseconds and decimals. In the meantime, advances in liquidity should bring comfort to those who are shocked to discover that the dollar they put in 10 years ago is only now available in full, and who may look longingly at the stock market as an easier, more predictable place to invest./
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 7
What Colombia’s Second-Largest LP Wants More private equity and fewer GPs, says its head of investing
Omar Rueda Galvis, ProtecciÓn
mar Rueda Galvis, vice presi-dent of investments for Colombi-an pension fund ProtecciÓn, says that private equity plays a vital role in the overall portfolio.
Rueda Galvis’ views are important for any pri-vate equity firm to understand. Colombia has become an important new destination on the fundraising trail because of the growth, so-phistication and international focus of its lo-cal institutional investors. ProtecciÓn is the second-largest pension fund in the country, with some $27 billion in assets under man-agement and a roughly 10 percent allocation to private equity. The pension commits capi-tal to established international groups and is nurturing a generation of local GPs.
ProtecciÓn also recently became a co-inves-tor, alongside Advent International, in Ole-oducto Central, Colombia’s largest crude oil transportation system.
In a February interview with Privcap, Rueda Galvis discussed the genesis of ProtecciÓn’s private equity program, the regulatory limits of its allocation policy, and what GPs need to know before they try to book a meeting withhim. PrivcapWhy in 2010 did your organization begin allocating to private equity?
Rueda GalvisWe were looking for exposure to different as-set classes. So we decided in 2005 to have a relationship with funds of funds in the inter-national world.
They make precise determinations of what the future runoff of that fund is going to be and invest in interest-bearing securities. Once one or two of the big states or municipal plans goes in this direction, it’s a domino effect. Illinois may be one of the first ones, because they have the biggest problem.
For Colombian pensions, we have different limits for local private equity and for offshore private equity. In both cases, we have a “five” limit—five percent for local private equity and five percent for international.
In 2005—as soon as the regulator allowed us to invest in this asset class—we started to have conversations with funds of funds in the international markets. That was the way
Click to watch this video at privcap.com
PE PERFORMANCE AND PORTFOLIO / INVESTOR PROFILE
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 8
PE PERFORMANCE AND PORTFOLIO / INVESTOR PROFILE
to tried to learn about private equity. At the same time, we supported the idea to create the private equity industry in Colombia. In other words, we were looking for good teams to manage the money for us.
At the beginning of 2008, before the bubble, we decided to have more exposure to sec-ondary portfolios and buyouts. We started to speak with another kind of GP—the well-known names like Blackstone, KKR, Lexing-ton, Partners Group. We were also working on the idea of having private local funds.
That was so difficult, because when we start-ed to compare the experience of the interna-tional teams with the Colombian teams, we recognized we have a huge gap. We realized we were going to have more risk with these local funds than the international funds.
We learned a lot. We developed an in-house due diligence process to pick the best manag-ers and decided to create a team focused on legal, risk, and investment areas.
PrivcapWhat role does private equity play in Protec-ciÓn’s overall portfolio?
Rueda GalvisThe reasons [for private equity] have to do with the target replacement rates of our af-filiates. That means that in creating our asset allocation, we must have a really good port-folio that is going to give a really good return over a long time horizon, with the idea to have a replacement rate around 17 percent. We started to see a lot of problems trying to get this higher return. So there is one way to try to get a lot of exposure to equity, and it’s through private equity.
PrivcapPlease paint a picture of the private equity portfolio that ProtecciÓn has built to date.
Rueda GalvisNormally when we want to invest in interna-tional private equity, we want exposure to the lower end of the market. We are looking for GPs with these kinds of strategies. Around 50 percent of our portfolio is focused on the Unit-ed States and the rest is global, meaning Eu-rope, Japan, Asia, and a little bit of emerging markets, especially Latin America. We have
lower exposure to emerging markets because Colombia is an emerging market.
PrivcapAre you working with the local market to en-courage further development of private equi-ty firms?
Rueda GalvisWe want to “copy” the standards that the in-ternational GPs have—we want the local GPs to have the same kind of standards. We have found that at the beginning of the process with the local private equity firms, we have a lot of issues about the information that they give us as investors.
In Colombia, the GPs decided to have the same management fee as the international GPs. In the international market, you can see a track record. Here there is no track record.
The challenge that we have right now is that private equity is important in our asset allo-cation. We are close to the maximum limit of 5 percent. So now we have to have anoth-er conversation with our regulators and try to show them how important it is for us to have exposure to alternative investments. We would like to increase this limit—maybe 5 percent more.
PrivcapColombia has become a popular place not only to deploy private equity capital, but from which to raise capital. What should an inter-national GP know about your program before trying to set up a meeting?
Rueda GalvisBefore we have any kind of meeting with a GP, at the beginning of every year we have our asset allocation where we ask what kind of strategy we should focus on in the private equity program. For example, [we decide] if we would like buyouts, or secondaries, or the mid-market. This year, we believe buyouts are not the best idea. The market is expensive, so we are thinking about other kinds of strate-gies.
In 2005 we started to build the private equity program. Right now we have too many GPs in the portfolio. So we are in the process of try-ing to cut to a minimum number and work with them./
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 9
finish
PE PERFORMANCEPanelists from Siguler Guff, Cambridge Associates, and StepStone Group on co-investment rewards and risk, performance of 2004 vintage, and fund-management missteps that can shave off points. We also take a look at Brazil’s PE funds.
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 10
PE PERFORMANCE AND PORTFOLIO / PERFORMANCE
Click to watch this video at privcap.com
The 2004 VintageSituated several years before a massive downturn, vintage-year 2004 is—unsurprisingly—a lackluster performer. But our experts say LPs exposed to the 2004 vintage did well compared to other asset classes.
pressed by the respectable showing of funds in the lower quartile. “Those funds had an average net IRR around 7 percent, which pretty much beats half the years since 1986,” says Elio. Overall, Kester says, it’s important to assess a vin-tage year within a broader context. In 2004, for in-stance, the economy was emerging from the dot-com crash.
“Looking at the numbers, what we see is some cor-relation between coming out of recessionary peri-ods and funds formed at the peak of the market, versus the bottom of the market,” says Kester. “In 2004, you’re on an upswing. You’re starting to get loftier valuations, loftier entry multiples, and lev-erage is starting to come back. So we’re likely to see ’04 look more like 2012, 2013, or even where we are today.”
Further breaking down the 2004 data, it becomes clear that certain strategies greatly outperformed others. Perhaps the biggest winners were energy funds, which boasted an average performance of 19.49 percent. Are managers of these funds smarter or were they just lucky?
“The energy space in the mid-2000s just boomed,” Elio says. “There are very few funds that I’ve seen go ‘full cycle,’ but there are a few energy funds that in-vested very quickly during that time period, exited those investments fully, and now no longer exist. So it was a good era.”
By contrast, growth equity funds are the clear lag-gards, with a scant 4.24 percent net IRR. “A lot of growth equity managers may have been investing a tad more in venture-like investments as opposed to more classic growth equity as we’ve come to de-fine it today,” Auerbach explains. “So that could
or investors in funds launched in 2004, the big performance news is this: for that year at least, the notion that picking the right GP is essential to performance fell flat on its face. Strategy selection clearly won the day.
Data from Cambridge Associates peg the pooled av-erage net IRR for the 2004 vintage at 11 percent; that’s at the low end of 10-year pooled performance numbers for funds launched in the preceding dec-ade. But there is a strikingly narrow spread be-tween returns of top-and lower-quartile funds. The top-quartile averaged 14 percent IRRs, versus sev-en percent for the lower-quartile. That seven per-centage point difference is by far the smallest mar-gin in relative performance among funds launched from 1994-2004. For example, top-quartile funds from 2001 returned 36 percent; the lowest-quartile returned 10 percent.
The 2004 numbers surprise Kevin Kester, a manag-ing director at Siguler Guff, “I would have thought that some managers in that 2004 vintage would have quickly invested their capital in ’04 and ’05 and been able to exit or recap businesses in ’06, ’07 and early ’08 and generate higher IRRs at the up-per-quartile level,” Kester says.
The 10-year mark is useful for drawing solid con-clusions. “Most funds don’t really settle into their ultimate performance levels from an IRR perspec-tive for six to seven years,” says Andrea Auerbach, managing director and head of private investment research at Cambridge Associates. “Taking a look 10 years on, things should be settled in terms of how it’s all going to end.”
StepStone Group partner Michael Elio is more im-
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 11
PE PERFORMANCE AND PORTFOLIO / PERFORMANCE
easily be a factor in the performance of the growth equity category within the ’04 benchmark.”Other notable performers were European buyout funds, which outpaced their U.S. competitors, re-turning around 13 percent, compared to 10.63 per-cent for U.S. funds.One of the most important statistics in private eq-uity, at least for limited partners, is the distribu-tions to paid-in multiple. The DPI for the 2004 vin-tage year stands at 1.02 percent, which means that LPs are basically back to even.
“The average DPI from ’86 to ’04 is about 1.4 times,” Auerbach says. “So 2004 is pretty bad in terms of getting your money back on a timely basis. But there’s still money on the table that we’re waiting to see.”
Kester believes the lingering effects of the last re-cession may still be affecting the 2004 DPI. “For 12 to 18 months, there were a couple quarters where literally no deals were getting done,” he says. “That had to take its toll on that 2004 vintage. My guess is that the duration of the 2004 vintage year is cer-tainly going to be longer.”
So what’s the takeaway for LPs? Should they con-tinue to invest in an asset class where they put in a dollar and 10 years later they get that dollar back? That’s a long time to wait, even though there is cer-tainly still value to be harvested in the 2004 port-folio.
“That’s part of the bargain to get those outsized re-turns,” Elio concludes. “That said, we’re in a much more mature market today, so I’m hoping that, with more liquidity in the public markets, we’ll get more liquidity in our market as well.”/
MICHAEL ELIO Elio is a partner focusing on global investments at StepStone Group. Prior to StepStone, he was a managing director at ILPA, where he led pro-grams centered on research, standards, and industry-strategic priorities.
ANDREA AUERBACHAuerbach is a managing director at Cambridge Associates. She heads the U.S. private equity re-search team, which performs due diligence on in-vestment opportunities in private equity, mezza-nine, and distressed markets.
KEVIN KESTERKester is a managing director at Siguler Guff and a member of the investment committees for var-ious funds. He is a senior member of Siguler Guff’s investment staff and oversees the firm’s Small Buyout Opportunities Funds.
EXPERT BIOS
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 12
PE PERFORMANCE AND PORTFOLIO / PERFORMANCE
Ten Years In: 2004 Looks Like a LaggardA comparison of private equity fund vintage years, all measured rough-ly 10 years after their respective vintage years. For example, the 2001 vintage is as of Q2 2010. The private equity fund vintage year 2004 is as of Q2 2012. 2004 is among the weaker performers by this measurement.
Vintage Year20042003
2002
2001
1999
1998
1997
1996
1995
1994
Pooled Return (%)10.6316.17
20.26
24.12
16.15
8.40
6.27
10.68
21.44
24.23
Upper Quartile (%)13.7617.78
27.15
35.83
19.62
16.56
12.59
11.52
30.97
24.33
Lower Quartile (%)6.637.24
10.66
10.22
7.74
6.22
-0.20
-0.93
-0.14
0.36
TVPI1.601.73
1.82
1.88
1.84
1.45
1.32
1.49
1.92
2.07
2004: Energy, Europe Stand TallA comparison of the sub-strategies feeding into 2004’s overall PE performance shows an outperformance of energy funds and an underperformance by growth equity funds. At the bottom of the table is a comparison.
Vintage YearAll US PEU.S. Buyouts
U.S. Growth Equity
U.S. Mezzanine
U.S. PE Energy
Europe PE
Pooled Return (%)10.6310.84
4.24
5.94
19.49
13.05
Upper Quartile (%)13.7613.63
NA
NA
NA
19.45
Lower Quartile (%)6.637.47
NA
NA
NA
9.02
TVPI1.601.63
1.23
1.28
1.72
1.63
Even Steven: 2004 Investors Get Their Principal BackTen years after the formation of 2004 vintage PE funds, the funds are on average just beginning to return called capital back to investors, mean-ing a huge amount of unrealized value remains in the GPs’ portfolios.
2004 All US PE DPI* (arithmetic mean) 1.02
*What is the distributed to paid in (DPI) ratio? The proportion of “Called-down” capital that has been distributed back to LPs.
Source: Cambridge Associates
Source: Cambridge Associates
Source: Cambridge Associates
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 13
Making Co-investment WorkThe popularity of co-investment—investing alongside managers rather than in their funds—is soaring. LPs want in on the action. One reason is the availability of low-fee and no-fee structures. Another is the chance for LPs to get better control of investments. But with reward comes risk.
PrivcapIt seems every LP in the world wants to co-in-vest alongside GPs. Why?
Michael Elio, Partner, StepStone GroupSurprisingly, lower fees are not the primary driver. There are lower net fees in the long run, but LPs are looking to boost performance and get more control of where their dollars are spent. It’s been difficult for them over the last few years to get all the allocation they need from some of the top-tier managers. Co-in-vestment is a way to control more money.
PrivcapKevin, Siguler Guff has a fund of funds, but you also invest alongside your own GPs as well as other GPs. How has that worked out?
Kevin Kester, managing director, Siguler GuffWe co-invest up to 30 or 40 percent of a typ-ical fund. The reason is selection. We believe we can pick very good opportunities on a deal-by-deal basis. We have the resources and the talent, and we believe we can identify better risk-reward opportunities. But we see a tre-mendous amount of deal flow, and to put to-gether a successful co-investment program, you have to see a lot of opportunities.
PrivcapYour co-investment portfolio has generated an IRR of 27.1 percent. Is that better than your fund IRR?
KesterIt is. We’ve added a significant amount of al-pha through our co-investment activities.
PrivcapAndrea, how does Cambridge track co-invest-ment?
Andrea Auerbach, managing director and Head of U.S. Private Equity Research, Cam-bridge AssociatesThere are over 40 co-investment topic vehi-cles we use to track co-investment as part of our benchmarking. So we’re aware of how discrete co-investment vehicles are perform-ing. And the trend of fund of funds pursuing 30 to 40 percent exposure in co-investment gives us another way to peel out performance. But the best benchmark is against the perfor-mance of private equity investments on a cal-endar-year basis.
PrivcapSo we know the benefits of co-investment if things go right. What are some things that can go wrong?
ElioSelection and execution. When you choose a co-investment program, you’re building a portfolio on your own. That’s a new skill set. And execution—if the GP calls, you need to be there with the money. Kevin mentioned that Siguler Guff can do everything from A to Z. But most LPs, their process stops around P. In that kind of environment, you need to make sure the execution happens.
KesterThe risk is in not having a plan, not under-standing what you’re investing in. We spend a lot of time with GPs to understand the dili-gence they’ve done, but we come to our own
Click to watch this video at privcap.com
PE PERFORMANCE AND PORTFOLIO / PERFORMANCE
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 14
decision about risk and reward. And if you can’t do that, you probably shouldn’t be co-investing, be-cause you’re going to have a deal blow up—it’s just the law of numbers—and that’s going to be a zero on a line item in your portfolio. It’s no longer a zero inside a fund that no one ever sees. And if you can’t defend it and explain why you made the decision, what went wrong, and what was done to salvage the investment, you’re going to get shut down. People will stop investing with you.
AuerbachThere’s program risk, process risk, and resource risk. If I don’t specify exactly what we all agreed
we were going to do, then the powers that be may not like the volatility of my results, and then my program is at risk. Process risk is: Do you have it set up so you can rapidly address the opportunity, maintain your guidelines, and complete and execute an investment? And then, resource risk: There are a lot of in-stitutional investors who are armies of one or two, and a lot of their co-investments are fire drills. You may get that last call and not have enough of a window to assess all the risks. And lastly, there’s relationship risk: If I keep politely declining or if I’m not being respon-sive, I may not get the widest funnel of op-portunity—and that may have adverse effects on my program’s performance./
PE PERFORMANCE AND PORTFOLIO /
•Has invested $1.2B in directs, $1.9B in co-investments •Began direct investing in 1995, co-investing alongside GPs in 2004 • Since 2007, has completed 58 co-investments via two Small Buyout Opportunities Funds • Siguler Guff’s Small Buyout Opportunities Fund I has posted 27 co-investments • Those 27 co-investments have a portfolio-level IRR of 27.1%
Siguler Guff Co-investment Facts
Panelists Michael Elio, Kevin Kester, and Andrea Auerbach
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 15
Grabbing deals is often a priority for GPs, but many do not focus on optimizing the performance of the fund. Common missteps can cost funds precious points of IRR, experts tell Privcap.
low and steady IRR does not bring the glamour of a smash-hit deal. So a lot of GPs focus on the latter and neglect the former, concentrating on blockbuster deals and forgetting they have a fund to manage.
“I don’t think any fund manager intentionally tries not to optimize a fund,” says Kevin Kester, a man-aging director at Siguler Guff, speaking at a re-cent Privcap roundtable. “But human nature, fund structure, and other pressures often create a situa-tion where fund managers produce excellent deal-by-deal returns but lose precious IRR points.”
Sell When It’s Time to Sell Another way managers shave points off their net IRR is by not selling when the markets say sell.
“There’s a lot of ‘I’m not done with my value-creation plan’,” says Andrea Auerbach, a managing director at Cambridge Associates. “Managers don’t acknowledge the possibility that maybe they should sell right now.”
It’s a hard decision to make. But Auerbach says it’s a primary driver of top-quartile performance: selling when it’s time to sell.
Pacing and calling capital when you need it—those are two more imperatives for effective IRR man-agement. “Another is deadwood,” says Michael Elio, a partner at StepStone Group. “When you get an opportunity to dispose of smaller, less successful companies in your portfolio, take it and move on. A lot of GPs fall in love with deals and think that, giv-en a little more time and capital, they might rise to the occasion. That’s rare. Get rid of them as soon as possible.”
Timing is crucial in making returns. One way to
manage the timing to raise IRR is the “European waterfall,” which directs more capital back to in-vestors earlier in the life of a fund and boosts net IRR.
“IRR is so time-sensitive that steps you can take early in the life of the fund to affect cash flow both in and out are incredibly important,” Kester says.
Consider the Dividend Recap Many GPs get capital back to investors earlier via dividend recaps. But they’re not always the best op-tion.
“Managers need to find the happy medium be-tween when is the right time to do a dividend re-cap and when is the right time to sell the compa-ny,” Elio says. “Too often folks lean toward ‘Let’s do a dividend recap, pull out as much as we can, and ride this as far as we can go.’ We saw what hap-pened in the last downturn.”
Often managers put a company into a process and if the bids don’t hit their number, they do a lever-aged recap, return money to the LPs, and play on. This is popular now, given where interest rates are and the availability of credit, but it raises questions.
“What’s the debt-to-EBITDA of that company?” Au-erbach says. “Is it greater or less than what it was before? Is it a covenant-light package? How bat-tle-ready is this capital structure for what might be coming down the road?”
Still, if managers know they’re going to sell a com-pany, then they should think about a dividend re-cap right away. “It’s a great way to move some IRR points forward and lock in some returns,” Kes-ter said. “And if you don’t sell the company, well, you’ve already done the dividend recap. You haven’t waited 12 months.”/
PE PERFORMANCE AND PORTFOLIO / PERFORMANCE
Click to watch this video at privcap.com
Maximizing IRR
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 16
PE PERFORMANCE AND PORTFOLIO / PERFORMANCE
Data on the performance of Brazilian private equity is thin, but Spectra-Insper says it has evidence of recent momentum By David Snow
his is what the development of an asset class in an emerging market looks like – sparse and fragile at first, with strengthening numbers as the years go by.
Or at least that is the analysis of Spectra-Insper, a partnership between Brazil’s Strategy Center of In-sper and Spectra Investments, which has built a da-tabase of private equity funds across Latin America. For the Brazilian market, Spectra-Insper says it has information on 172 funds from 78 separate firms.
Article ImageWidth: 4.7884 inHeight: 4.38 in
The overall average gross IRR of the Brazilian funds tracked is 22 percent. Spectra-Insper says that per-formance between 1990 and 1998 was weaker than US private equity funds during the same pe-riod. But the period between 1999 and 2008 saw a string of successful Brazilian PE fund performanc-es, albeit small in numbers, comparatively.
In a recent white paper, Spectra-Insper chalked up this later, stronger performance to: “(1) the Bra-zilian economic boom between 2004 and 2012 (2) still limited competition for deals in Brazil and (3) the fact that Brazilian PE and VC managers are be-coming more experienced, thus allowing for bet-ter performance.”One of the most vexing issues of investing in the emerging markets is the lack of performance data, allowing global investors to benchmark per-formance not only among managers within the country but against other markets.
But as is well known to investors in the most de-veloped markets, collecting performance data from GPs is difficult. Spectra-Insper says it has built a database using “data collected from PPMs and from interviews.”/
Vintage Year1990
1993
1994
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Gross IRR (%)21.7
26.0
15.7
7.8
9.8
-6.7
20.2
23.3
60.3
13.1
47.7
20.0
77.2
60.0
23.8
11.9
Number of Funds2
2
2
6
4
5
4
4
4
3
1
1
2
1
2
2
Post-Crisis Surge: Brazilian PE Fund Performance
Brazil Funds Gaining Strength
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 17
PE PERFORMANCE AND PORTFOLIO / EXPERT PANEL
Four LPs Talk PortfolioPrivcap contributing editor Tom Franco recently talked with thought leaders from the LP community to learn their views on private equity in the portfolio, and the future of the asset class
ARDIAN’S INDEPENDENCE DAYHow Paris-based AXA Private Equity became Ardian; important trends in PE. With Vladimir Colas, Ardian
PrivcapHow would you describe Ardian’s business as it’s transformed from AXA private equity? What’s changed and what’s the same?
ColasWe were founded in 1996 with $100 mil-lion under management. Now we’re close to $50 billion. Becoming independent was a natural evolution for us. What’s changed is the ownership of the management compa-ny. Out of the 320 employees, almost 300 of them participated in the spinouts. AXA
hasn’t sold its private equity holdings—they’re still our clients. More than two-thirds of the capital that we manage is third-party: pension funds, sovereign wealth funds, in-surance companies around the world. Noth-ing has changed with the investment pro-cess, the investment committees, the funds that we manage.
PrivcapHow would you describe the business?
ColasIt’s a multi-strategy business within private equity. We manage close to $50 billion, of which around $25 billion is a fund-to-fund program. Within that program we have pri-mary and secondary expertise—a mid-mar-
Ferdinand SeibertManaging Director Zurich Alternative
Seibert has previous-ly worked as investment principal at Swiss Life Pri-vate Equity Partners and has held positions in M&A at CSFB and BNP Paribas. He received degrees from Frankfurt University of Ap-plied Sciences, University ofSt. Gallen, and EM Lyon.
Vladimir ColasManaging Director
Ardian
Colas joined AXA Private Equity in 2003 and previ-ously worked in BNP Par-ibas’ sell-side equity re-search department.
Scott KalbExecutive Director
Sovereign Investor Institute
In addition to his role at SII, Kalb is CEO of KLTI Advisors and the vice chairman of the World Economic Forum Global Agenda Council on Long-Term Investment. Previously, he was CIO and deputy chief executive of the Korean Investment Corporation. He holds de-grees from Oberlin College and Harvard University.
Frank BrenninkmeyerManaging Director Performance Equity
Prior to joining Performance Equity, Brenninkmeyer was a vice president at GE As-set Management and also held operational positions at a European retailing or-ganization. Brenninkmeyer received degrees from the University of Notre Dame and the UCLA Anderson School of Management.
Watch the Video Watch the Video Watch the VideoWatch the Video
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 18
PE PERFORMANCE AND PORTFOLIO / EXPERT PANEL
kets buyer group active in continental Eu-rope and a growth-equity team. We have a co-investment program active in North America, Europe, and Asia. Finally, we have a direct infrastructure practice.
PrivcapHow would you describe the value that Ard-ian brings to GPs in the co-investment con-text?
ColasIt’s an important aspect of our investments. When we make primary commitments with a private equity manager, we hope to build a broader relationship. We like to provide pri-vate debt in some cases to make secondary acquisitions or help a manager open doors for add-on acquisitions in industries or coun-tries where we have specific knowledge. On the co-investment side, we have strong po-sitioning because we’re a direct group, but we’re also a fund-of-funds group.
PrivcapYou mentioned secondary activity. What are the underlying trends driving that market?
ColasThrough our fund-to-fund platform, we de-ploy roughly $2 billion a year on the second-ary side and about $1 billion on the primary side. Both are strong legs to our platform. Regulation is making it more expensive for banks and financial institutions to hold pri-vate equity. You have strategic shifts; some pension funds deciding to go direct will want to sell some fund portfolios. More gen-erally, private equity is no longer an alterna-tive asset class. It’s a several- trillion-dollar industry and needs a robust secondary mar-ket.
PrivcapWhat innovations to the secondary market do you see coming down the pike?
ColasWe’ve seen more secondary demand from LPs for new assets classes like energy, real estate, and infrastructure. A lot of that demand is from LPs who have exposure to those pro-grams and want to increase it. We’ve seen more GP restructurings, but have been cau-tious on that side of the secondary market.
PrivcapEarlier you talked about Ardian’s roots in Europe’s middle market. Can you talk about what you see as the opportunities there in this post–Great Recession environment?
ColasHistorically, we’ve done well taking coun-try-specific companies. Our roots were in France, taking French companies and making them European leaders. Now we have an established practice in Germany and Italy. On the direct side, the strategy is taking smaller companies and helping them become European or world leaders. It’s a good time for us to be putting capital to work in Europe.
A GLOBAL INSURANCE GROUP’S BET ON PEThe role of PE in the insurance portfolio. With Ferdinand Seibert, Zurich Alternative
PrivcapFrom your perspective at a global insurance company, what role does private equity or private capital play in the portfolio?
SeibertAs with most insurance companies, our port-folio is dominated by fixed-income instru-ments and publicly traded securities. Hedge funds, private equity, and private debt take a backseat to these fixed instruments. They’re in favor because they’re expected to gener-ate alpha to compensate for their illiquidity. On the one hand, you have the publicly trad-ed instruments offering liquidity, so it can affect when the insurance company needs to rebalance its portfolio. On the other hand, you have illiquid instruments that don’t al-low rebound financing, but they generate al-pha. It’s always good if we can demonstrate a clear difference between public equity and private equity.
PrivcapLet’s talk about the fun part of the job: select-ing managers. How do you assess a group’s operating capabilities?
SeibertThe words “operating executive” cover a va-riety of skill sets and levels of involvement in companies, and commitment and time
Tom Franco, a partner at Clayton, Dubilier & Rice, leads the firm’s fundraising team. He is a board member of the Private Capital Research Institute and Privcap.
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 19
PE PERFORMANCE AND PORTFOLIO / EXPERT PANEL
to that endeavor. One has to go beyond the mere title of “operating partner.”
Many executives with operating capabilities come with prestigious titles that may be helpful to start with, but one has to look be-yond this to understand what they’ve done. What have they accomplished? What were situations of adversity they had to overcome? Do they have the credibility to speak with CEOs of portfolio companies? Are they able to share insights gained from working on difficult situations with the management teams of portfolio companies?
PrivcapWhat do you see as primary benefits of a co-investment program?
SeibertCo-investments have a lot of benefits. The most measureable types are the financial ones in which it’s the mitigation of the J-curve and performance improvement due to less fee drag. The less tangible aspects are the ability to better understand a GP and sat-isfaction of the private equity staff, who of-ten enjoy working on co- investments.
BREAKING DOWN GP SELECTIONTips for manager selection; strategy lessons from GM’s pension group. With Frank Brenninkmeyer, Performance Equity
PrivcapWe’re here to talk about GP manager selection and other important topics. Frank, things change, markets change; what worked in the past may not work in the future. How does that impact your deciding whether to commit to a manager?
BrenninkmeyerI’d start by saying that the core levers of value creation are pretty well known. You have fi-nancial engineering, cost restructuring, top-line improvements, and expansion strate-gies. Those will remain relevant for a period. Then there’s the skill that managers need to implement value-creation strategies. Do they have the ability to repeat this over time? Do they have the skills in-house to do that? Do they have the ability to create and craft a portfolio? That’s what we’re looking for, and that will continue.
PrivcapPerformance Equity is recognized as one of the more experienced fund-to-fund adviso-ry organizations. The firm’s history is con-nected to the General Motors Pension Group. How does that affect your thinking today?
BrenninkmeyerOur heritage coming from the world’s larg-est corporate pension certainly influences us in a number of ways. The most important is our mindset, which comes from manag-ing an asset class within a broader portfo-lio with the explicit goal of alpha generation and to assist the organization in achieving its return hurdles. I would contrast that with a more benchmark-driven type of approach where relative performance is a larger driv-er of portfolio construction and investment mindset. Our mindset really comes from the GM heritage to be global in our reach and opportunistic in our scope. We are agnostic to strategy, geography, stage.
PrivcapIn terms of evaluation of managers, do you see a lot of research on the individual part-ner? Is it the firm franchise that drives per-formance, or is it dumb luck? How do you sort those different factors?
BrenninkmeyerWell, that’s a complicated question, and we’ve spent a lot of time thinking about that. It’s talent and luck. Luck plays a pret-ty important role in investing, but many people are not that interested in admitting that, or even estimating what percentage of their return was attributable to luck.
WHAT THE SOVEREIGN FUNDS WANTThe $6 trillion SWF sector wants more than re-turns from its GPs. With Scott Kalb, Sovereign Investor Institute
PrivcapYou’ve taken your experience as the chief in-vestment officer of Korea’s sovereign wealth fund and repurposed it under a new ban-ner, the Sovereign Investor Institute. Tell us about that initiative.
KalbThe sovereign fund community is not very well understood by the financial commu-
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 20
PE PERFORMANCE AND PORTFOLIO / EXPERT PANEL
nity. They are underserved, and they are in need of a forum where they can get together and move their agenda forward. So I define the sovereign funds very broadly. It’s sover-eign wealth funds, sovereign pension funds, social security funds, central-bank reserve funds—so all these very large government funds. Our goal is to create the largest pri-vate-sector think tank for that community. What we want to do is give them a platform to get together and exchange ideas—it’s such a globally diverse community. We also want to be able to bring in outside experts, govern-ments, academic leaders, and leading figures from the asset-management community so that they can also learn and figure out what’s going on in the sovereign fund community.
PrivcapHow much has the sovereign wealth fund sector grown in recent years?
KalbThese large government pension funds are investing in equity, they’re investing in real estate, infrastructure, private equity, and they’re insourcing. And even central- bank reserve funds are doing things differently now. So it’s very dynamic, and it’s a very new phenomenon. If we go back to 2000, let’s take the sovereign wealth funds, for exam-ple. There were only 14 of them. Today there are 75. There are new sovereign wealth funds being created practically every week. The sov-ereign wealth fund community is of interest because they’re so dynamic. They already manage about $6 trillion. They have an aver-age asset size of about $90 billion and average head count of about 200 people.
PrivcapHow should GPs approach the sovereign wealth opportunity?
KalbBefore, we had maybe a handful of institu-tions that were large and had internal ca-pabilities. Now there are over a hundred of them. And they’re growing by $400 billion to $500 billion a year in their assets, and they’re deploying 25 to 30 percent of their capital in alternatives, including private equity. So these guys are not content to simply be price takers or trend acceptors.
They have a mandate to try and develop their
capability, or to help develop the capability of their own domestic financial markets. And so they’re very active in trying new things and engaging differently. They’re moving aggressively to become more of price set-ters and trendsetters. And that means that they’re approaching the GP community dif-ferently. The days of simply saying, “I’ve got a great fund—do you want to put money into it, and I’ll make you return and give it back to you?” are gone. There will always be a place for good funds; I don’t think that goes away. It’s just that it’s much more now about partnership. Sovereign funds are looking for more than simply a fund product.
PrivcapSo it’s more than returns?
KalbReturns are a requirement. If you don’t have those, you can’t get in the game. So there’s a checklist. A sovereign fund is going to look at a firm that has a track record or individ-uals that have a track record. They have to have good numbers; they have to have good institutional quality; they have to have good risk control; they have to have good servicing capabilities; and they have to be transparent. But then, once you’ve satisfied those boxes, what are the intangibles? The intangibles are: Is this a firm that’s going to help me in accomplishing my mission overall? Are they going to be responsive? Will they come and help do seminars for us? Will they help us with education and training? Will they be flexible in how they work with us?
PrivcapShould GPs be worried if the sovereigns have a lower cost of capital?
KalbI don’t think so. What GPs need to do is think about changing the way that they interact with the institutional community. The old models are going to go away, and you’ve got to think about how you’re going to work with these guys./
Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 21
Explore Privcap’s vault of recent videos forecasting 2014’s critical trends
From the ArchivesDEALMAKING
Sale-Leaseback Case Study: Kraft HeadquartersWith Jason Fox of W. P. Carey
Exploring Exits in African Private EquityWith Michael Rogers of EY and Michelle Essome of African Venture Capital Association
Partnering with Chinese Developers With panelists from Century Bridge Capital
Expert Q&A with Ed Kleinguetl With the managing director of Grant Thornton
Devices of Value: Baird Capital Backs Insightra MedicalWith Mike Liang of Baird Capital
REAL ASSETS
How Small Institutions Tap Private EquityWith Martin Day of Caledon Capital Management
Profitable, Responsible Real-Asset InvestingWith experts from EY, CIO Vision Brazil Investments, and Denham Capital Description
COMPLIANCE & REGULATION
Escape from Lehman: Trilantic’s White-Knuckle SpinoutWith Charlie Ayres of Trilantic Capital Partners
Riding the Crowdfunding Wave With Rich Salute of CohnReznick
How to Subtract Value with Bad Tax MovesWith experts from Washington National Tax - McGladrey and Arsenal Capital Description
Valuing a Minority Stake: It’s ComplicatedWith experts from McGladrey, W Capital, and StepStone
FUNDRAISING & IR
Fighting for JOBS With Rep. David Schweikert
What’s a “Liquid Alternative”?With panelists from KKR, Pantheon, and Morgan Stanley Wealth Management
Hamilton Lane: Private Equity’s NAV ChallengeWith Erik Hirsch of Hamilton Lane
Trilantic: Fresh Powder, Flexible ApproachWith Charlie Ayres of Trilantic Capital Partners
Co-Investing: Selection Skills Are ParamountWith Peter Cornelius of AlpInvest Partners
HUMAN CAPITAL & CAREERS
In Search of Diverse ManagersWith Carmen Heredia-Lopez of Chicago Teachers’ Pension Fund
Operating Partners in PE Firms: Making It WorkWith Aaron Money and John Roach of FFL
Wanted: Emerging Managers with VisionWith panelists from MVision and Gulf Capital
Upgrading Lower-Middle-Market CompaniesWith Randy Mehl of Baird Capital
�
PE PERFORMANCE AND PORTFOLIO / ARCHIVES
How does Gen II partner with private equity firms for success?
Gen II is a third-party private equity fund administrator, and we’ve been doing it longer than anyone. We work closely with private equity funds to support their back office.
We’re the team that oversees reporting to investors, whether that is for financial statements, capital calls, or distributions. We keep the official accounting books and records for the firm. We maintain the investor data-base. We manage investor allocations and prepare waterfall calculations. We support the CFO or the person within the organization who has CFO-func-tional responsibility. We bring an expert platform to our clients—a platform of people, process, and technology.
/
SPONSORED CONTENT
Click to watch this video at privcap.com
Please contact Gen II at [email protected] • www.gen2fund.com
with Steven Millner, Managing Principal, Gen II Fund Services
Expert Q&AAbout Gen II Fund ServicesGen II Fund Services, LLC is an independent specialist provider of highly customized, client-centric accounting and administrative services to private equity industry spon-sors and investors worldwide.
