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Impact Investing

IPE special report May 2018

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Germany starts to get the bug

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Investment patterns in Germany have traditionally been rather conservative and so it’s no surprise that investment in private equity in are a relatively new concept. Frankfurt’s Neuer Markt has excited investors and it appears they are starting to talk about serious investment in this asset class. According to Patrik Roeder, managing director at Julius Baer in Frankfurt, alternatives in general in Germany are novel and largely restricted to hedge funds and private equity. “In reality, the assets going into these classes are actually quite small. Many people are talking about it but there are only a few institutions that are willing to look at it and to invest in it,” he says. Those that are willing to invest in it and do so tend to be the larger insurance companies and a handful of the larger pension funds.
With regards private equity Roeder says that lack of investment is partly down to the fact that it is very time consuming to evaluate companies. Once an institutional investor has decided to invest in private equity, there’s the question of to what extent it should be a part of the strategic asset allocation. According to Roeder, there are very few institutions with more than 5%. “The question then is, if it is only 5%, is it worth spending so much time and resources on this asset class,” he says. Nevertheless, although there are few over 5% this would almost have been unheard of a few years back and the prospects for private equity in Germany are looking up. “I definitely see more interest in that area from the large institutional clients,” says Roeder.
And such is the sentiment of James Dilworth, head of asset management at Goldman Sachs in Frankfurt, who says that there is a renewed interest, largely from the insurance sector and less so from pension funds. From the mid 1990s to 1998 alternatives grew in popularity in Germany until the LTCM turned people off private equity (and any type if managed investment deemed less than transparent). “We then had a renewed interest in the latter part of 1999 going into 2000. We saw an incredible amount of money being offered to the PE community and there was a lot of money chasing a lot of deals,” says Dilworth.
Six to nine months ago, the private equity team at Goldman Sachs were apparently saying they had never seen so many attractive investment opportunities, especially in Europe, but that they had also seen a huge amount of junk as well. “You had a lot of people looking to invest in private equity and consequently a lot of people were going out and trying to raise capital,” says Dilworth.
The market has appeared to calm down since the frenzy of 1999 and early 2000 but Dilworth is convinced the serious investors are still very interested in private equity. Shocking returns from the TMT sectors during 2000 don’t necessarily bode for a repeat of the late 1980s and early 1990s. “People have sobered up a little bit. We saw a lot of people coming to the market and some of these were less serious than others but the big private equity providers have not felt any dampening in the interest for their products,” says Dilworth. Many of the smaller, more opportunistic outfits that put together perhaps one or two very specific ventures in the TMT sectors have since disappeared.
On the demand side it is insurance companies driving the market. “There isn’t a funded pension market in Germany yet and the corporates who fund their pensions liabilities on the balance sheet are not quite ready to take on a private equity commitment, it’s too much of a commitment.” Insurance companies have recently been offering 7% on their life policies and they are looking for sources of even greater returns and the alternatives are the next progression from equities. “Today the insurance companies are taking a more sophisticated approach to building their portfolios with an interest in private equity and hedge funds,” says Dilworth.
It is hard to forecast but it appears likely the Pension kassen will be given more freedom in its investment restrictions and head more towards an Anglo-Saxon approach which would enable them to invest in alternatives. In private equity most of the money in Germany is not actually invested in Germany, instead invested in diversified, global private equity funds. Germany, often considered to be conservative in its approach to risk and investing appears to be a market worth watching.
In neighbouring Austria, the market remains smaller but the past 12 months have witnessed significant activity. Private equity has been in the ascendancy since 1997 when the government introduced federal guarantees for investment in alternative investment. “It allowed people to go out and raise funds essentially without a track record,” says Franz Krejs, managing director at Horizonte Venture in Vienna.
Since 1997, several funds opened and began supplying the Austrian market and, according to Krejs, there appears to be a new launch every week or so. There are up to 30 venture fund groups in Austria (the figure is hazy as many are still raising capital) and although this may seem modest when compared with the US or UK, the Austrian market has traditionally been very modest and such growth demonstrates the increasing importance of private equity.
Krejs says Horizonte is involved in the early stage technology sector and concentrates predominantly on biotech, IT and medical devices. Austria has a strong IT sector and there is a relatively vibrant market for investment in enabling software. “Of course we had the internet wave as well but that has to some extent subsided now,” says Krejs, adding “although the number of venture capital groups has multiplied there’s nobody who’s complaining about poor deal flows; the deal flow is actually quite strong.”
Nevertheless, the Austrian market remains restricted by its size and there are certain categories of private equity investment that are already becoming crowded and it seems unlikely the market can continue on its upwards trajectory. At the early stage, high risk end of the market, there are very few people active in that market but when it comes to development capital, buyouts and later stage deals there is lots of money. “If you go for second rounds of financing we generally don’t have difficulties enlisting funds in a short period of time. For the early stage it is far more difficult,” says Krejs. So in the early stage, there is a good deal flow but in the later stages there appears to be too much money and too few deals.
According to Krejs this is simply a question of risk- Most of the new outfits are inexperienced and shy away from start ups and early stage as it tends to be far more management intensive. There is likely to be more money coming into early stage- after all there are only three groups really involved in seed capital- 3i, Horizonte and Invest Equity sponsored by the Austrian, industrial bank Invest Kredit. 3i recently purchased Bank Austria’s old venture fund. “3i is interested in the market because it is near East Europe and it is very similar to the German market,” says Harald Parapatits, investment adviser with the group. He predicts there’s great potential in the Austrian market for MBOs and transaction-related business and the former will be one of the areas they focus on in the future.
One of the most significant Austrian deals was the capital raised by the biotech company Intercell, a company specialising in cancer vaccines. They have just closed the final of several rounds of financing and have raised DM120m (early stage financing).
In Switzerland, as in Germany, the notion of direct private equity investments is relatively novel. Swiss asset managers have traditionally invested in private equity, albeit through offshore funds but institutions are now looking at alternatives as a means of diversification. Says Mike McShee, managing director of Buck Heissman in Switzerland: “People are very conscious of looking at effective means of diversifying their pensions’ total portfolio. And they have been thinking a lot about assets where they may find true diversification for equity/bond portfolios and private equity is one of the classes they have been considering,” he says.
Most pension funds have yet to make significant allocations to private equity. There are a couple with a 10% or so allocation to alternatives and last year VEF, the Swissair pilots pension fund and the Nestlé pension fund announced they were to invest in private equity and alternatives. McShee says that a significant number are looking at alternatives: “I’ve got the feeling that the Swiss funds, in terms of actual movement into these classes, have moved further than most Europeans.”
Daniel Gloor, head of asset management at the Canton of Zurich says his fund invests in both US and the rest of Europe and, at the end of last year, the fund had SwF250m (or 1.3% of total assets) in private equity. “Private equity has become more attractive for many investors…people know what it means now and it has been given more attention by Swiss pension funds,” he says. Canton of Zurich makes around two or three private equity investments a year but it has to be selective as there are a lot of second rate deals on the market “Six years ago nobody knew about private equity and in the last two years I get two calls a day about private equity so that suggests to me that there is a lot of rubbish in the market,” says Gloor. The Canton remains rather cautious about the Swiss market as few projects ever turn a profit and the market is small and rather Illiquid.
Felix Kottman, managing director at Complementa, says more pension funds are investing somewhere between 2% and 5% but the main debate is whether to invest in the US or European private equity. The problem with the approach in Switzerland is an obsession with net asset values, an inappropriate measurement for private equity. “Looking at private equity from a traditional standpoint, this is not the way is should be. It is a long term investment and by pretending to have a daily NAV people may think they can get into and out of a product whenever they like,” he says.
Swiss institutional investors have apparently yet to appreciate that, if you invest 5% in private equity, it is likely to sit there for 36 months or so until it begins to make money. US houses don’t provide a daily/weekly NAV as it is relatively meaningless. “How are people able to provide a daily or a weekly or even a monthly net asset value on a private equity product? If you talk to people in the US, they say this is impossible,” says Kottman.

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