If transparency is one of today’s buzzwords in investment management, then one area where simplicity and clarity have perhaps been lacking to date has been in alternative assets and private equity in particular.
Bad Homburg-based Feri Alternative Assets, however, is one firm attempting to shine a little light on the venture capital industry with a system of ratings designed to aid clients in their search for appropriate funds.
Dirk Soehnholz, managing partner at Feri Alternative Assets, explains that Feri’s reputation for mutual fund ratings, particularly in the German market where it developed its service at the end of the 1980s, prompted the firm to look at other areas where ratings systems could be a useful tool for investors.
“We established Feri Alternative Assets in 1999 and then started to look at the other areas in the house and what they were doing to see how we could develop.”
Soehnholz notes that Feri had already developed a track-record as an adviser on investment in hedge funds and private equity since the early 1990s. “We had quite a lot of experience in this area doing the usual due diligence and also investing in funds of funds and looking at their own due diligence processes, both with German and international institutions.”
This experience prompted the firm to focus on one of the major stumbling blocks in the market for so-called alternative assets such as private equity – the difficulty in being able to compare funds on a like-for-like basis.
“What we found was that the questions asked of different funds are usually very similar. However, using the same due diligence questions different fund operators come up with different results because they have different internal weightings that correspond to the importance they give to different issues. For example, one firm will put the accent on the importance of the management team rather than the track record, and vice versa. This was the reason that we decided to develop these private equity/ hedge fund rating systems.”
Initially Feri takes all the fund information available, including due diligence requirements and then groups it into 15 categories. It then assigns different weightings to these categories.
Within these categories, the firm then drills down to a set of sub-factors, which it also calibrates. The end result is a type of scoring system from which Feri can introduce a system of benchmarking.
The benchmarking, Soehnholz says, could in its simplest form be a comparison of average assets under management per investment professional in a particular private equity firm.
“If there is a new fund coming into the market, then the difficult issue can be to raise money for the fund. If, for example, there is a e3bn target for the fund and they have a hundred investment professionals, then we would calculate the average investment per professional, then ask whether this is a high or low expectation.
“You can go further then and ask how many companies the private equity house already has in their portfolio and deduct that part of the portfolio from the capacities they have going forward.
“The end result is that the same information leads to the same results, even when it is evaluated by different people.”
One area where this can be crucial to investors, he notes, is for past performance: “We don’t rely as heavily as others on past performance and our system has only a 20% weight for performance in private equity funds. Past performance is just that, past, and we are trying to identify the best funds in the future.”
The system is one that Feri has developed, albeit with slightly different nuances, for private equity and hedge funds worldwide.
“Within private equity we have little differences between venture, buy-out or mezzanine funds, but basically the system covers all types of privately placed funds.”
With several hundred funds currently being assessed by the firm, including the majority of the funds that have come on to the market since the beginning of 2000, this somewhat unique ratings coverage has proliferated strongly.
Says Soehnholz: “I think on the private equity side there is nothing comparable – at least I haven’t heard about it. On the hedge fund side there are a few houses doing this. In our favour though we have more than a hundred factors that we consider before we rate a fund and most of these factors are benchmarked across hundreds of funds, so it is a very detailed system.”
The system is restricted to client use only at the moment on the firm’s customised portfolios. But while the service is not yet sold to third parties, it is an option that Feri is considering
“Our sister company, Feri Trust, started their fund ratings system in 1990 and only published it in 1998 and during that time they only used it for internal purposes.
“We constantly think about selling this to investors, but at the moment we don’t get money from clients and we are completely independent in terms of rating.
“We have presented the details at some conferences and interest was quite high. We have also showed this to a number of potential investors and they really liked it.”
One player in the private equity market, Henderson Private Capital, is presently operating a joint management venture with Feri for its selection of fund of funds, by committing itself to using just A and B rated funds on the Feri scale.
Ratings run from ‘investment grade’ (A and B) to ‘questionable’ (C) and not applicable (D and E).
Institutional clients using the Feri rating system will typically be provided with a summary of the 15 assessed categories and the ratings given per category, as well as a standard five- to seven-page summary of the fund.
For internal presentations to institutions, the consultant will also run through the hundreds of factors considered for every fund, allowing the investor one-off viewing access to the entire database.
Ask why the Feri ratings system should hold any water in the market and Soehnholz flags up some interesting statistics.
“It’s interesting if you look at the funds we rate. As a whole, we only rate funds that are interesting for our customers. If we assume that this is a kind of industry average we have, then it is notable that of the buy out and venture funds we rate in the US, 25% receive investment grade ratings. For European venture funds this is only 7%, so we feel this is intuitively right for the industry.”
Feri adapted the same technology and a similar approach for hedge fund ratings, where Soehnholz says it appears to be working well: “In fact there are a few hedge fund products out there in the market that only include Feri A and B rated funds.”
As a product, the consultant believes its ratings system is particularly good news for investors in non-public markets and private placement products.
“Everybody demands transparency now, and one element of minimum transparency, for example, is that you should be able to track the positions of a hedge fund down to seeing how much Deutsche Telekom you hold in a portfolio of a fund of funds.
“The other element is fund selection. Why does a fund of funds manager select a particular fund?
“Our system means that an investor, whether they be looking at private equity or hedge funds, gets the same results to these questions. It provides significant transparency in terms of fund selection,” says Soehnholz.