For investors large and small
Charles Soulignac of Fondinvest Capital discusses the strengths and skills required of the fund of funds manager
The growth over the last three years in transaction volume and capital raised is evidence that private equity is now a legitimate investment sector in Europe.
p Investments increased 49.8% from 1997 to 1998 with a total of e14.5bn invested.
p A total of e20.3bn were raised in 1998 versus e8bn in 1996.
p 7,628 investments were completed, a 20% increase from 1997.
p Private equity investments represent approximately 0.2% of the EU gross domestic product.
The 1999 figures and those of this year should show a more significant increase, mainly from the development of investments in new technology fields.
The growth of fund raising among private equity firms has been driven by the basics of supply and demand. Managers are making increasingly large equity commitments, especially in leveraged buyout transactions and on new technology sectors, and therefore want to raise larger funds. At the same time, in the face of limited returns from bonds and public equity, investors are drawn to private equity by the good performance of the recent past.
The progressive adoption over the last 10 years of standard methods of performance measurement confirms the increased maturity of the private equity sector. Our firm, based in Paris, played a major role in the development and implementation of such methods in Europe, encouraging more meaningful follow-ups for investments, leading to greater accuracy and transparency in the information provided to investors. In addition, management teams can now show track records going back 10 to 15 years.
Some European investors regard private equity as an attractive class of assets in terms of diversification and performance. Private equity is of interest in so far as it is not correlated with the stock exchange markets.
However, some institutional investors have not developed any coherent strategy of approach for this area. A strategy for intervention (allocations of assets, human resources) must be defined to invest in companies, funds or funds of funds .
Performance figures compiled by the European Private Equity and Venture Capital Association (EVCA) show an average internal rate of return for the top quartile of 28.2% over the last 10 years. This compares favourably to more traditional investment vehicles, at a 15.1% premium for public companies and 18.2% premium for the Euro bond.
The best performing European funds show returns just below 30%, comparable to US funds performance. However, despite the strong performance of the upper quartile (28.2%), the overall IRR level reached only 11.3% in 1998, diminished by the poor returns of the lower quartile.
The EVCA figures show that some funds can achieve negative performances.
MEANS TO INVEST IN PRIVATE EQUITY
An investor having an interest in private equity, has at his disposal various ways of investing.
1. Acquisition of stakes in companies. First of all, the investor must define a strategy for assets allocation – which kind of acquisition (early, expansion, buy-out etc), which category of firm, which sector of activity, and which country.
For that purpose, he will have to set up one or more specialised teams.
Apart from having a variety of means at his disposal in order to obtain a satisfactory performance, the investor will have to focus on a limited number of type of investments.
To build up a diversified portfolio of companies, it is necessary to have a significant degree of asset allocations.
One option is for the investor to have very skilled teams and to invest 20–25% of the amount of the fund (or of the funds), and make other institutional investors invest in the rest.
2. Acquisition of stakes in private equity funds. Due to the diversification of risk obtained, investing in a fund seems to be easier than investing in a company.
But at the same time, as explained above, there is a wide range of fund performances. To deal with this, it is necessary either to have significant means to be able to invest in many funds or to be an expert in investment in funds that select top tier funds.
However, although some investors have invested in funds in the past, they have never set up any system of analysis since this activity was mainly carried out by people working on other asset classes.
The actual situation is that some institutional investors are putting money in fashionable funds such as new technologies, or investing following just a single visit of a placement agent. In general, they invest in a limited number of funds. Past experience shows poor performance from these strategies.
3. Acquisition of stakes in private equity funds of funds. Two types of fund of funds appear in private equity:
p Primaries, which invest in funds at their inception,
p Secondaries, which invest in existing funds.
These funds of funds are designed for all types of investors, such as those with limited amounts for allocation or those that do not want to set up a private equity team. But also some large investors will allocate money for specific reasons (diversification, area, sector, secondaries).
In the selection of the funds, our company takes a pro-active approach. Having been in funds investment for many years, we have acquired comprehensive knowledge of the main players and their development within the industry.
Without rejecting the proposals of placement agents and the opportunities they offer, our approach consists in selecting teams able to raise money in the forthcoming years.
These teams are in general ‘under the radar’, and we bring them recommendations on strategy of investment, terms and conditions of the funds, and other matters.
This preliminary approach makes it possible gradually to carry out due diligence. During 1999, even though more than 200 proposals in primaries fund opportunities were received, we only invested in eight of them.
Over the years, a rigorous methodology was developed on all the aspects constituting the management of a fund of funds.
As in any diagnostic analysis, some key points must be taken into consideration, such as the quality of the team, the strategy of investment, the environment, and obviously, the performance.
But, our diagnostic analysis showed that each case, and therefore each fund, is a particular one. Thus, neither a general questionnaire nor a check-list could produce an analysis, or an investment decision.
Our method is based, above all, on the quality of the members of the team, their experience, the cohesion of the team, and their motivation.
All other parameters are analysed in the smallest detail, but approached individually according to their fund, country, and type of intervention.
The secondaries fund of funds we developed focus on selecting the best teams and avoiding the bad ones.
Performances are analysed in various ways. Our focus is primarily on how the performance was generated, but it is also important to check the quality of the team.
Our people in charge of analysing a fund will always keep in mind that the past performance has nothing to do with future performance.
THE SELECTION OF FUND OF FUNDS MANAGERS
Once the decision has been made to invest in a fund of funds, the investor must select a management team –not an easy task, given the proliferation of European firms over the last year.
Generally, the qualities required by a manager of funds of funds of private equity are rather similar to those of a manager of an investment fund.
The quality of the team managing the fund of funds is of prime importance. Two key points appear significant to them:
p The length of time actively involved in investment in funds.
p The performance realised by the invested funds.
In Europe, and particularly in continental Europe, very few teams and even fewer people can show such expertise.
Our firm has raised four funds of funds, representing a total of over r320m under management.
These funds were raised from US and European investors, and sponsored by CDC Participations, the private equity subsidiary of the AAA/aaa institution, Caisse des Dépôts.
Primaries funds of funds, Fondinvest I (r50 m) and Fondinvest III (r70m in the process of fund raising) are focused in Europe.
Secondaries funds of funds, Fondinvest II (r70m) and Fondinvest IV (r130m) are focused worldwide.
The management team has a collective expertise of 50 years in company analysis and 35 years in private equity investment.
Fondinvest Capital funds bring investors results through:
a) Product :
p Investing indirectly in funds with top tier performance,
p Obtaining a high degree of asset allocation, because of the diversity of the categories of investments, by industry type, by manager and by country.
p Avoiding costs of maintaining a team specialised in the private equity,
p Allocating adequate funds in terms of amount and time.
c) Return on investment :
p Producing top quartile private equity performances,
p Giving quick return on the investment.
Because of our seniority and solid presence in the market, we can deal with a huge range of funds.
As it is, in the US some funds are raising money ‘only by invitation’ because of their seniority and quality of performance. These managers aim to set up a round table of well known investors having ongoing financial resources and a comprehensive understanding of private equity.
An investor with a limited expertise in private equity, or with a limited amount of asset allocations on private equity could not invest in this type of fund.
Due to our long and proven expertise in funds investments, we bring to these managers added value in the realisation of their funds, and in the reporting aspects. Thus, these funds managers are pleased to have us investing in their funds.
For secondaries funds of funds, we have a significant share of the European market.
The investments cover mainly repurchases of stakes in existing funds and portfolios of funds at the ends of their lives. Then we entrust selected specialised and autonomous teams to manage the liquidation of these portfolios of share-holdings.
The market of the shares acquisition in existing funds, as in portfolios, is a recurrent market. However, reasons for transfer change down the years – liquid assets, re-allocation of the assets, and the understanding of the private equity.
Thus, we, through our secondaries, as well as primaries funds of funds, can be of interest to investors of all sizes.
Our team has demonstrated through their performance their expertise by investing in over 100 funds, and by managing four funds of funds. So, Fondinvest Capital, one of the leaders in private equity funds of funds, can offer high quality and performance to investors.
Charles Soulignac is the chief executive officer of Fordinvest Capital, part of the CDC Group, in Paris