Managers eye Europe and Asia
Within the overall table of Top 400 European fund managers (IPE June 2006), there are 56 fund managers running private equity portfolios.
At one end are the big mainstream managers for whom private equity is a small percentage of their business. For instance, JP Morgan, the biggest fund manager with a private equity business, runs €665.9m-worth of private equity assets under management, representing just 1.2% of its total assets under management from European institutions. Merrill Lynch, another large player across the board, manages €289.6m of private equity funds, equal to 0.4% of its European institutional money.
However, the table also features large mainstream managers for whom private equity is a sizeable proportion of their business.
Russell Investments runs €5,278.5m-worth of private equity investments, equivalent to 20.7% of its European institutional money.
UK investment house Gartmore runs €1,284.09m of private equity investments, with €2,200m of commitments - equal to 8.9% of total assets under management from European institutions.
Peter Gale, the head of the Gartmore team, began investing in private equity when he became the investment manager of the National Westminster Bank Pension Fund in 1991. Gartmore was bought by the NatWest in 1996 and Gale's team was incorporated into the Gartmore structure.
Gartmore's investment management clients include pension funds, insurance companies and endowment foundations from Europe, the US and Japan. It runs private equity mandates for two large institutional investors.
Gartmore's private equity investments
combine investing in private equity funds, principally in Europe and Asia, with co-investments directly into private companies alongside the key private equity managers.
"The investment focus is on Europe," says Nick Shaw, deputy managing director, Gartmore Private Equity. "We feel the US market is both more competitive and expensive, whereas there is less competition in Europe, because there are significantly fewer private equity managers. Furthermore, structural change in Europe means there are better investment opportunities."
However, he also sees Asia as giving potential for returns: "The growth rates are attractive and the pricing of investments tends to be lower."
Shaw says the key difference between Gartmore and its competitors is that it believes private equity investing is a two-stage process.
"We like to search out globally the best markets to invest in," he says. "Then we try to find the best managers. In contrast, many private equity fund of funds simply go for the best managers overall. In addition, our rates of return have been very attractive, particularly in co-investments." Another mainstream player is Danish investment house Bankinvest. Just over 11% of the European institutional money which it manages is invested in private equity.
The investment house started its private equity activities nearly 10 years ago, selling products to pension funds using its own inhouse resources.
"We started with core competences in the biotech listed area, which we then moved into a venture fund on the biotech side," says Bjarne Thorup, chief investment officer, Bankinvest. "There was a window of opportunity in the late 1990s - we had an advisory board doing some good work on the listed side, and we decided to transfer this success to venture businesses."
Bankinvest now runs four biotech funds - two of which are already in the black -- and two IT funds, all in venture. It also runs an alternative technology fund, New Energy Solutions, investing in Europe and the US, and PENM, launched last spring, which invests in unlisted companies in new emerging markets. Funds are sold primarily to existing clients.
Thorup says that Bankinvest intends to stay as a niche player.
"In total, we have DKR 4.5bn (€600m) under management in venture and private equity - that is quite big compared with other Scandinavian companies," he says. "Of course, if we get business from the UK or Germany that is welcome, but we are essentially a Scandinavian player. We believe in being close to our clients - if you don't deliver, you shouldn't expect to have the business."
In absolute terms, the largest amounts of private equity funds are managed by a mixture of companies.
Runner-up to Russell is the Swiss-based LGT Capital Partners, which runs over €5,000m-worth in private equity commitments, or 60% of its funds under management.
LGT CP is the alternative investment arm of the LGT Group, a family-owned financial services group, and has been in business for 10 years. Its first private equity programme, the Castle Private Equity fund of funds - a joint venture with Partners Group - is listed on the Zurich stock market.
It offers global and European focused comingled funds of funds and secondaries funds to a global client base of mainly pension funds and insurance companies.
"New entrants into private equity investment are now going for one or two globally diversified fund of funds, or for a combination of one European and one US-focused fund of funds provider," says Tycho Sneyers, partner, LGT CP. "That means we need to be able to provide those kinds of fund. On the other hand, the key providers in Europe, including ourselves, are also offering more specialised funds than five years ago."
Sneyers says that as the fund of funds business matures, the more experienced investors may start to use fund of funds as satellites rather than core positions.
"That means managers will have to come up with more specialised offerings such as small and medium-sized European buyouts - which is one of our specialities - or, for example, Asian private equity fund of funds."
He says that what distinguishes LGT CP from its competitors is the alignment of interest with its clients: "Our shareholders - the LGT Group - and all our senior professionals invest substantially in our own funds."
And he says the company will not fundamentally change its business model. "Private equity is a long-term business, with a time frame of typically 10 years," he says. "Besides alignment of interest, clients also want to see manager stability and a safe pair of hands."
The other major Swiss representative on the list is Strategic Capital Management.
Unlike most of the other companies, some of which are listed, SCM - founded by Stefan Hepp in 1996 - is an independent management-owned gatekeeper rather than fund manager. Its clients come from Switzerland, Scandinavia, Germany and the US (the Ohio State Pension Fund has recently become a client). Most of its business comes by word-of-mouth.
"Our business model is to provide advisory services to investors who want to build an inhouse private equity programme, but who need external partners," says Hepp, who is also the company's chief executive officer.
"Many large European institutions are finding the fund of funds route is not cost-effective because of the double layer of fees. In addition, it can generate too many overlaps within the asset allocation. In contrast with funds of funds, where the client delegates the decisions, our investment process is driven by the client."
He says the key to results is to invest money by identifying prime return opportunities.
"These days, general partners can be reluctant to accept money from new sources," he says. "The issue is how to get additional clients on the manager's list of limited partners. The fact that SCM has not yet lost a single client and thus represents a stable investor base is a definite advantage in accessing new and broadening existing manager relationships."
SCM's market is the larger pension funds.
Although SCM is the only gatekeeper in Switzerland, Hepp says that does not necessarily give it a marketing advantage.
"Typically, it's a substitution," he says. "The client has to ask themselves if they want to control their investment, or to delegate it. However, some of them use smaller amounts in funds of funds to test the market, then shift to direct investing in single funds to have more control."
But he does say that not being affiliated to a fund management group and not being engaged in direct private equity investments on a company level is necessary if other fund managers are not to see SCM as competitors, and therefore to be more willing to give them full information about investments.
Other big players originally grew out of pension schemes. Hermes Pensions Management is owned by the UK BT pension scheme for communications workers. It also manages a large percentage of the Royal Mail pension scheme, and has a range of other clients.
However, Hermes Private Equity (HPE), its private equity arm, is run solely on behalf of the BT and Royal Mail schemes.
PE has two main activities, investing both in private equity funds as a limited partner and directly by leading UK buy-out transactions.
The direct investment activity was launched in 2003 as a start-up, although there had been piecemeal direct investment before. "Our direct private equity operation is very much buyout-led," says Rod Selkirk, chief executive, Hermes Private Equity.
"We invest directly in the European buyout marketplace, sourcing and carrying out our own deals. On the other hand, our funds investment activity covers both buy-outs and venture capital and we have investments in over 60 private equity funds globally."
All the investment management is carried out in-house. "We have sufficient scale to go direct, and it avoids one layer of fees," says Selkirk.
Although Hermes has a captive relationship with the BT pension scheme, the long-term strategy is for the company to branch out. "The objective on the direct side is to build a track record with a view to bringing in external capital," says Selkirk. "It makes sense to have less than half our capital coming from one source, and it also avoids accounting issues.
However, on the funds side, we do not have any plans to raise external capital. The BT pension scheme has increased its allocation to private equity to 5% of the scheme and we will deploy that money, as opposed to diluting it by raising external client money."
Dutch investment house Mn Services was originally the fiduciary manager for the PMT metalworkers' pension scheme and now in addition provides services for other pension funds and institutional investors in Holland. The whole process including due diligence and fund selection is managed inhouse by a five-strong team.
From 1998 onwards, Mn Services has built up a programme of single private equity funds and now invests in 80 partnerships.
Both buyouts and venture are included, with a geographical split of 70% US and 30% Europe and the rest of the world. The company is now contemplating expanding its programme into Asia and other emerging markets.
"Although 95% of our portfolio is single funds, we use funds of funds for niches we want to investigate, such as seed venture capital," says Wouter Pelser, director of asset management, Mn Services. The only segregated mandate run by Mn Services is for the PMT, which currently has 4.5% of its assets invested in private equity, although the target is 5%. Apart from PMT, Mn Services provides investment services for 14 other clients within and outside the metalworking sector.
"We don't manage private equity portfolios for these mandates, because private equity is not in our clients' strategy of asset mix," says Pelser.
"We are seeking clients but our primary focus is on fiduciary mandates, creating a balanced portfolio and then adding private equity. We are not looking to manage stand-alone private equity programmes, because of our identity as fiduciary manager. Private equity is a very opportunistic asset class with good returns, but not all pension funds are choosing to use it."
However, Pelser envisages that attitudes towards private equity will become more positive in the near future.
"The focus will be more on using more non-traditional types of fund, because of FTK and the need to incorporate hedging mechanisms," he says. "Of course, tools such as SWAPs can be used, but once they have considered these, pension funds will again look for returns, and private equity is a very good asset class for enhancing returns. We see private equity as an integral part of a balanced mandate and I expect to see more interest."
In contrast with some of the more well-established players, Spanish fund manager Fonditel is blazing a trail through the less mature Spanish private equity market.
Fonditel manages the largest corporate pension scheme in Spain, belonging to communications company Telefonica, as well as a constellation of Telefonica-affiliated pension schemes, independent pension schemes and various individual pension plans.
Spanish pension funds are prevented by law from investing in funds of funds, and although many of them invest directly in Spanish private equity funds, Telefonica is the most active pension fund in terms of investing internationally, and the only one with a dedicated manager for private equity investing.
Fonditel bought its first private equity funds in 1999, but it was only last year that it hired a dedicated investment manager to increase its private equity exposure. Already the exposure has increased significantly and now represents 3% of total funds under management.
Of the original portfolio, about half were Spanish funds, the rest being US, pan-European and global technology funds.
Fonditel has now added more pan-European and US including large buyout and mid-market funds, and will probably start investing in Asia next year. About 25% of its portfolio is invested in megafunds.
According to Fonditel, Spain should see much more private equity activity when plans to relax the law banning the use of fund of funds by pension funds take effect.