Partners Group and the private equity drought
Posté par Cyril Demaria dans Uncategorized, listed private equity le 23 janvier 2012
(This paper was originally published by Swiss Business – http://www.360journal.com/CD/SwB_6_2011_32-34.pdf).
The asset management company, Partners Group, regularly delivers good results. Will this well-oiled marketing machine get through the upcoming private equity drought?
By CYRIL DEMARIA
In July, the asset manager Partners Group announced in Baar its first semester results with a net inflow of EUR 2.1 billion (CHF 1.75 billion). Over this year, the Group expects to gather in EUR 4-5 billion (compared with EUR 4 billion in 2010), and is confident about its future, “since public pension plans are set to increase their allocation”, explains Anna Hollmann who is in charge of public relations. This performance is even more impressive (see “Key financial figures”) when considering the strong headwinds that the private equity sector is facing as a whole. Partners Group seems so far unaffected.
Given its pragmatism, the odds seem to be in favour of Partners Group. A first example of its ability to change was its switch to a new strategic baseline, choosing to stay away from an approach where private equity and public equity were blended in an ‘equity strategy’. But the company faced difficulties in convincing investors to change their asset allocation framework, which differentiates listed and non-listed assets and puts them in different categories. Partners Group hence exited from wealth management and hedge fund management to focus on funds of funds (an investment strategy consisting of holding a portfolio of investment funds, rather than investing directly in private companies).
The Group was then private, still nimble and in an uplifting environment over 2000 to 2006. As Partners Group went public in 2006 (see “Evolution of Partners Group AG’s stock price”), private equity was in favour with investors. Major American endowments (such as Yale and Harvard) were showing annual performances above 15%, essentially thanks to alternative investments such as private equity and hedge funds. Nevertheless, pure funds-of-funds strategy became an increasingly tough sell from the 2007-2009 crisis and beyond. The management fees that are charged to investors (so called ‘limited partners’) are difficult to justify, particularly given the poor performance shown by funds of funds (see “A management fee game”) compared to their peers.
To mitigate the impact of management fees, leading endowments and pension funds have developed a policy of co-investing with fund managers – and sometimes taking shares in the fund management companies themselves (so called ‘general partners’). Co-investing grants limited partners with an access to the underlying investments themselves (hence reducing the marginal amount of fees paid per euro invested). Partners Group followed through.
Focus, focus, focus… but on what?
As Partners Group derives 91% of its income from management fees, this pressure towards a fee reduction mechanism did not bode well for the future of the Group. Firstly, because the fees stream is shorter in the case of direct investments and therefore more volatile: a fund of funds is created for twelve to thirteen years (with guaranteed fees over that length of time), whereas a co-investment lasts only three to five years. Secondly, to have access to co-investments, it is necessary for Partners Group to continue investing in private equity funds. These funds are the key to direct access to co-investment opportunities. As funds of funds are less likely to gather interest due to poor performance, Partners Group may have difficulties in keeping access to private equity funds and hence to attractive co-investment opportunities.
Over the last five years Partners Group has developed infrastructure and real estate programs in order to diversify its offer. The new focus is ‘private markets’ (hence shifting away from ‘equity’). The purpose is to mitigate the impact of the private equity cycles on its product performances, and develop new niches. Another focus is to offer its clients exposure to emerging markets, even though these markets have yet to prove their resilience – just like Partners Group’s good fortune. Indeed, by diversifying, the group might lack focus going forward, which according to academic studies is the source of financial performance.
There is size… and size
Indeed, as stated by Katarina Lichtner, head of research at Capital Dynamics, a spin-off and competitor of Partners Group based in Zug, funds-of-funds managers have hence to take a decision on their business model: either remain small niche providers (such as Alpha in Zürich, focused on Eastern and Central Europe) or become globally integrated firms. Partners Group seems to have chosen the latter through organic growth with 14 offices worldwide.
This choice may however expose Partners Group to a lack of momentum, as the competition has launched a wave of acquisitions. Axa Private Equity, which has taken over the private equity activities of the Swiss Winterthur, has acquired private equity portfolios and businesses from Citigroup (USD 1.7 billion in 2010), Bank of America (USD 1.9 billion in 2010), Natixis (USD 718 million in 2010), Mizuho (USD 500 million in 2011) and HSH Nordbank (EUR 620 million in 2011). Axa Private Equity itself is now officially for sale. Carlyle has entered the fray by acquiring AlpInvest in 2011, managing EUR 32.3 billion, in order to prepare its listing and diversify out of direct investments. HarbourVest went public in 2007 and acquired the Swiss listed structure, Absolut Private Equity, (for a total of USD 806 million) over the summer of 2011. Partners Group declined to comment on these acquisitions, but remains singularly out of the news in this concentration game.
Size indeed matters when it comes to regulatory burden
The fact that the private equity sector is headed towards a storm of regulations will necessarily impact Partners Group. The Alternative Investment Fund Manager Directive, the Basel III Agreements for banks, the Solvency II Directive for insurances, the Dodd-Franck Act and the Foreign Account Tax Compliance Act (FATCA) in the US will dramatically change the landscape of practice. According to Anna Holmann, “the increased complexity is a competitive advantage for Partners Group due to [its] global positioning combined with local knowledge [and] large in-house structuring/tax/legal/compliance teams. Partners Group is already regulated by several regulators worldwide.”
Indeed, the company operates under different regulations worldwide. However, the Basel II Agreements failed to recognise that funds-of-funds are a risk diversifier for investors. Their risk-return profile is specific and should be treated as such by the solvency ratios. Funds-of-funds managers remained muted, just like for other debates which involve the future of the asset class as such. This lack of interest in communication, lobbying and interaction with the public might backfire strongly.
The disappointing, to say the least, recent evolution of Partners Group’s stock price is hinting that the fortunes of the Group remain to be proven under stress. The lack of transparency of its activity essentially lumped in a black box of 91% of its revenues, the absence of the Group in the major concentration operations and the lack of perspectives for internal talents might prove to be a challenge difficult to overcome – and probably not through trial and errors as in the past. The fact that seven financial analysts have downgraded the stock recently (only one upgraded it) confirms that doubts loom over the preparation of Partners Group to face the private equity drought.
Succession issues rear their head for general partners
Posté par Cyril Demaria dans Uncategorized le 23 janvier 2012
(This paper was originally published by AltAssets – http://www.altassets.net/features/100009694.html)
The passing at the age of 71 of Theodore Forstmann, founder of the LBO firm Forstmann Little in 1978, illustrates one of the main challenges that private equity will face soon. While general partners regularly complain of the reduce commitments of institutional investors (banks, insurance groups and pension funds), notably due to the new solvency ratios and the different American and European regulations, the real challenge that the asset class will face is the management of succession at the helm of general partners.
The generation which has lived the « »goldne twenties » of private equity in Europe (1980-2000) and the « golden thirties » in the US (1970-2000) will have to eventually leave room for the next one. This succession will reschuffle the cards in private equity. This was recently confirmed at the Buyout Texas conference by Tully Friedman, founder in 1984 of the LBO firm Hellman & Friedman. According to him, up to 50% of general partners of LBO funds in the US could disappear due to a lack of succession management.
In an industry where strong personnalities and egos are fighting for deals, but also for the favours of the media, succession management remains a taboo question. If founding partners of general partners can think that the future of their firm without them is a minor question, this is a different matter for the limited partners. LPs kno that the performance of funds is highly correlated to the reputation, the know-how and the personnality of the general partners. Academic studies have proven that the negotiation power of the general partners is related to their past deals ; that the performance of general partners is largely recurring and is confirmed over multiple decades. The disappearance of the founders of the most famous general partners could radically question the two founding pillars of the future performance of private equity funds.
Succession is a particularly crucial stake for general partners such as Blackstone, KKR, Carlyle and other private equity giants (see table). These listed and unlisted groups depend largely on their founders-managers, in an industry where deals get done thanks to relationships, reputation, know-how and networks of individuals. It is an industry where deals are won thanks to the relationships between individuals and where arm’s length transactions are still dominating, even in deals above the billion dollar threshold of enterprise value.
A few examples illustrate the stakes of these successions. In France, the team of Apax France had to call back its retired founder Maurice Tchénio to be able to close on a languid fund raising. Along the same lines, the future of firms such as the fund of funds manager Adveq in Zürich, which has seen the departure of the two of its three historical figures over the course of the last two years has put the responsability of the management of the firm on the 61-years-old Bruno Raschle. Private equity is hence not exempt of succession issues, not only related to the age but also the sometimes outsized ego of the founders of general partners. The lack of planification of successions is a major operational risk looming on these structures.
It is not only the degradation of the future performances which is at stake, but also the creation of an unhealthy guaranteed income for general partners living out of their outdated reputation. Limited partners have developped a certain aversion to the idea of investing with emerging fund managers. Moreover, the new regulations have placed the bar very high in terms of critical mass necessary for a general partner to be viable, and have created barriers to entry. The new entrants are however, according to academic studies, proportionally performing better than already installed general partners. These new general partners will have the choice between giving up their ambitions or team up with less performing, but already installed, general partners. This is a sub-optimal choice.
Europe will paradoxically more affected by the risks born by succession, as there are very few foundations and endowments able to finance emerging general partners as this happens in the US. Family offices in Europe manage essentially old money and their aversion to risk does not support the emergence of new general partners (which are usually backed by these structures). New family offices, or family offices managig new money, tend to invest directly in non listed businesses and will not participate in the emergence of new general partners. The future of European private equity could hence be osillating between sclerosis and conservatism which is prejudiciable to investment returns always in high demand as returns from stock exchanges are degradating fast.
Comments on « Why We’re Preoccupied with Steve Jobs» (PeHub)
Posté par Cyril Demaria dans Uncategorized le 13 octobre 2011
This is a comment I posted on peHUB (http://www.pehub.com/122167/why-were-preoccupied-with-steve-jobs/)
Seen from Europe, these emotional expressions are a bit puzzling. Let’s go back to a few elements of perspective:
1. Steve Jobs was apparently a quasi-dictator, and not necessarily a model of management. The fact that Apple went down a first time when he had to leave and is expected to go down again after is death raises some questions about his qualities of manager. NeXT was a failure. Pixar was a success, but was it only Jobs who raised it to its status? Probably not.
2. Just like a few other public personalities (think Michael Jackson), contested human beings pass away and almost become saints. It would be good to keep some measure: what did Jobs really create in our world? He reused existing inventions and innovations for his own profit. He was a control freak which limited innovation spill-overs and the anti-thesis of open innovation. Is this really something we should praise? He was a good marketer, attentive to details and had a sense to identify certain trends. That’s probably closer to reality.
3. So why all this pathos regarding his passing? Maybe because Americans suddenly realize that the emblems of the rising 1970s, when VC was a cottage industry and innovation was possible because not only of ideas and capital, but also because clients were willing to take risks and trust Gates, Ellison or Jobs to deliver. These spoiled kids-entrepreneurs greatly benefited from an emerging and rich ecosystem, but did they nurture it back? Not really.
This is why the VC business model of the Silicon Valley is « broken» : instead of projecting the image of technology, openness and ciollective success, they symobilize a « get rich quick and don’t bother about the rest» . It’s not philanthropic self-serving reputational initiatives which will change that: they impoverished an ecosystem and the damage is not compensated in any way.
4. Jobs is gone before the real challenge will strike Apple: commoditization of its marketing innovation. The next industrial revolution, after the networks, is certainly not marketing fads such as Facebook, Zynga or Apple. It is, as usual, related customer empowerment: it was affordable electronic transmissions and communications for all in the Western world. It will be 3D printing, and hence the challenge to designers and marketers when everyone will be able to print a copy at home of an iWhatever for the hardware, and have inside an open source OS and free applications.
Apple is the contrary of customer empowerment: it is based on simplification, constraints and infantilization of customers. The passing of Jobs is sad as any human passing. However, hopefully the new Apple leadership will understand that to face successfully the upcoming challenges of personal production (ie the transition from the standardized gizmos to truly personal appliances) it has to embrace partnerships, open systems and customer input.
Not everyone accepts the frustration created by a corporate dictator. The figures of Android adoption (versus iOS) are just showing that: at the end of the day, we prefer freedom to Apple serfdom.
Presentation on venture capital in Europe
Posté par Cyril Demaria dans Uncategorized le 11 octobre 2011
Held in Luxemburg, at the initiative of the ISPIM.110830_VC_Presentation_CDemaria
Comment on « Edhec research reveals negative correlation between private equity deal performance and duration»
Posté par Cyril Demaria dans performance le 9 juillet 2011
Having read Edhec research reveals negative correlation between private equity deal performance and duration, a few thoughts came to my mind:
1. Comparing IRR without multiple on investment returns does not provide any valid conclusion for a limited partner in private equity. As a matter of comparison, Castle Harlan sold a company for USD 218 million that they bought the day before 190 million. That’s a 1.14 x return and a skyrocketing IRR.
Does it provide any good conclusion for a limited partner? No.
For at least two reasons:
i) the money will not « work» anymore until the limited partner reinvest it in another private equity fund, paying all the fees involved in due course and loosing the potential returns he could have made should the duration has been longer.
ii) the multiple as such is just very disappointing for a limited partner who usually aim at 2x on investment net.
2. By focusing on gross IRRs, the analysis does not take into calculation the transaction fees that a short duration and a high IRR investment involves versus a one-off deal done over a long duration. It does not take into account the cost of undeployed capital for the limited partner.
3. High IRR/short duration is usually analysed by limited partners as a quick flip. These quick flips are usually associated with opportunistic and low value creation work from the general partner. It is not replicable going forward and mainly discarded as an arbitrage deal.
4. IRR calculation relies on two assumptions which can be criticized:
i) an implied assumption that time has a pure discounting factor approach, which is not true in private equity.
ii) liquidity is a good thing, which not necessarily true. A study by Lerner and Cao (2005) on reverse LBOs shows that actually general partners sell too fast (on average 6 to 9 months) their portfolio companies and hence transfer part of their value creation (for which the limited partner has paid) to stockholders.
As a side and conclusive note, I would like to highlight that the confusion of « private equity» and LBO. LBO is part of private equity, as well as venture capital, growth capital, turn-around, distressed debt, mezzanine, etc.
Comments on « Private Equity Funds of Funds vs. Funds: A Performance Comparison» and related academic note
Posté par Cyril Demaria dans funds of funds, limited partners, performance le 30 juin 2011
Here is a short comment on a paper published by the Journal of Private Equity (Private Equity Funds of Funds vs. Funds: A Performance Comparison, Nathalie Gresch and Rico von Wyss, The Journal of Private Equity, Spring 2011, Vol. 14, No. 2: pp. 43-58), which is summed up like this:
Based on a comprehensive sample of 1,641 funds, this article investigates the performance of private equity funds of funds versus direct fund investments. On a risk-adjusted basis, funds of funds outperform the aggregated direct funds. When separated into categories such as buyout, venture, and fund of funds, buyout funds exhibit the most attractive risk–return profile. Analyzing how fund performance depends on macroeconomic variables, direct funds generate pro-cyclical returns: Returns increase with high public market performance and economic growth as well as declining corporate bond yields. For funds of funds, we cannot observe such a pattern.
A few elements surprised me:
1. In the Weidig & Mathonet study, the loss probability of 0% is on a 100% loss. A partial loss is possible according to their model (even though low: 1% for an average loss of 4%). The Gresch & Wyss analysis did not state this, and discards the results altogether.
2. Preqin as a source of data is not really the top notch. It’s either Thomson, or Cambridge Associates or State Street. Preqin aggregates heterogeneous data, and is not consistent in the treatment of the inputs. At least, the others have a consistent bias which allows a statistical correction. However, Thomson does not provide data on funds of funds cash flows, which is problematic (hence the work of Weidig and Mathonet, which is purely based on a model). Eurekahedge is supposedly doing it, but I guess that they suffer from the « Preqin syndrome» .
3. Page 11 in explanation of sample, there seem to be two misunderstandings:
> funds of funds cannot be aggregated and should actually be looked at according to their strategies. It is very unusual that FoF blend all the investment universe (actually, I do not know of any which does). For instance, either a FoF is dedicated to a region, or a strategy or both. Hence, a rigorous comparison methodologically should compare a proper blend of funds of funds and similar funds of funds strategy. Most of the funds of funds do not include real estate, mezzanine, natural resources, infrastructure, venture debt, timber and direct secondaries in their portfolio.
> the approach does not seem to take into account the fact that funds of funds diversify fund vintages (hence reduce the risk) more than a blend of direct investment funds.
4. I would also doubt that the approach really deals with the delicate question of fees properly (notably in the US & EU, the carried treatment is different, as well as the level of management fees). See page 15 (» net of fees» , no explanation).
5. Page 15 mentions « risk adjusted basis» , but does not provide explanations. I would be curious to know how.
6. Somewhere should be mentioned the « survivor bias» related to the source of the data, notably in Preqin.
7. The statement about « the downward bias» affecting funds of funds is questionable and unproven.
8. The note does not deal with the introduction of the FMV in the NAV calculation and its potential impact (in conclusion, it would have been interesting).
9. The statement on the « availability of credit [which] overstate [the] long-term performance» of LBO funds is highly debated in the academic literature… And should be considered carefully before being written like this.
10. Why is the pacing of funds of funds cash flows supposed to be better than for direct funds (page 18)? Maybe investors want to deploy their commitment (ie, put the cash at work) as soon as they can?
11. There is no mention anywhere of potential elements which are actually key:
> the fact that funds of funds reduce transaction costs in many respects (the mutualisation of the resources)
> the fact that funds of funds could be leveraged (the risk reduction effect is then transferred as a resource for LPs)
> why do LPs invest in funds of funds or direct funds? What are their risk/return appetite and expectations? How would you classify them? Do they really expect the same outcome (no)? Is there a pure risk/return approach in their will to invest in funds, funds of funds… (no)? etc.
Even though very developed on the statistical aspects, and impressive in the work realized, it ignores most of the specificities of the private equity business. This is a common mistake (Gottschald being one of the most emblematic) of academics who tend to apply reasonings coming from market finance or other sectors which are methodologically not relevant to private equity…
Presentation – Africités – Private equity and local public authorities
Posté par Cyril Demaria dans Uncategorized le 3 août 2010
091218 – Africités – C Demaria – Private Equity v2
A presentation (in French) made in Marrakech in December 2009 for the Congress of African cities and communities (Africités).
Quel avenir pour le private equity ?
Posté par Cyril Demaria dans Leveraged buy-out, corporate governance, performance le 31 juillet 2010
An interesting paper (in French) from the CEO of AXA Private Equity and my comments.
The Size of Limited Partner Icebergs
Posté par Cyril Demaria dans Uncategorized le 29 juillet 2010
This post was originally contributed on PEHub (http://www.pehub.com/77945/the-size-of-limited-partner-icebergs/)
General partners in private equity funds claim that a variety of global regulations – Basel III, Solvency II, the “Volcker rule” and the European Alternative Investments Fund Manager Directive – will severely restrict available fund capital, thus decreasing the amount of financing available to non-listed businesses. Not a good thing for economic growth, particularly when small businesses already are having trouble securing bank loans.
However, the situation is not as obvious as general partners describe it. First, funds are the emerged part of the iceberg in terms of private equity: Family offices, corporations (listed or not), sovereign wealth funds, individuals… a significant group of economic actors are indeed doing non-listed investments. This does not necessarily get into the figures reported by the professional associations (such as the NVCA, EVCA and others). In fact, they only gather statistics from their members, who are general partners in private equity funds.
This means that they are not capturing all the transactions: Small LBO is notoriously under-evaluated, and secondary operations largely ignored. Then, statistics are only aggregating what is communicated by the members: Uncooperative members and non-members are not submitting any data, which means that there is no way to know precisely the size of the private equity sector. In the US, there is hardly any association equivalent to the NVCA tracking LBO, mezzanine, turn-around, distressed debt and other private equity transactions.
Nevertheless, a small calculation helps to put the role of private equity fund managers in perspective. According to the latest statistics of the EVCA (European Private Equity and Venture Capital Association), European family offices have provided 4.2% of the 16.1 billion euro collected in 2009 (versus 4% of the 81.4% collected in 2008). This means that family offices have contributed up to 0.6 and 3.2 billion euro to the private equity fundraising in 2009 and 2008, respectively.
Swiss private equity fund managers have collected 907 million and 3.2 billion euro in 2009 and in 2008. Assuming that family offices contribute in Switzerland by the same percentage that they do in the rest of Europe (roughly 4%), they have invested an amount of 36.3 and 128 million euro in 2009 and 2008. According to Highworth Research, there was 355 declared family offices in Switzerland. Assuming that they were managing at least a 50 million euro wealth per family office (at least), this represents an aggregated 17.8 billion euro under management.
Four percent of this amount represents around 710 million euro allocated to private equity. Assuming that that is renewed every five years (which is the duration of the investment period of a private equity fund), then 130 million euros is invested every year in private equity (which is the amount roughly calculated for the Swiss family offices above, for the year 2008). However, family offices are in fact investing between 25 to 35% of the amounts under management to private equity according the the different surveys (that is to say 0.88 to 1.24 billion euro per year).
For sure, Swiss family offices are exporting capital towards the rest of the world, but this represents a substantial part of the amounts collected in Europe (aside from other family offices which are based in the UK, France, Germany and other European countries). This means that the amounts invested in funds represent only a small part of the total invested in private equity in Switzerland. An identical calculation could be made with sovereign wealth funds.
What are the consequences of this reasoning? For sure, regulation will increase the costs of general partners, at a time when limited partners are putting pressure on management fees. GP margins will decrease and the investment teams will have to restructure. Their expertise will concentrate. However, as some limited partners have discovered, this expertise is difficult to replicate. In particular, general partners have an access to a higher quality of deal flow, and they have refined methodes of analysis which lack to the non experts. Expertise and know-how will be the differentiating factors between the teams which will survive and the ones which will disappear during the coming private equity cycle – not necessarily IRRs and multiples.
This is due to the fact that limited partners do not necessarily want the highest (and more volatile) returns, but a more steady and predictable stream of results. One option is to team up with general partners through schemes which have so far proved unsatisfactory: Fee reduction mechanisms are discriminatory; whereas co-investment schemes are producing biased portfolio strategy investments. Reviewing the future cooperation between general partners and limited partners will imply understanding the differences of their asset allocation constraints and return expectations. That may also mean the end of the private equity fund structures as we know them today.
Cyril Demaria is the author of “Introduction to private equity”, The Wiley Finance Series, Wiley & Sons, June 2010
As credible as Chinese statistics…
Posté par Cyril Demaria dans Uncategorized le 6 août 2009
So you really believe what a private equity fund manager says? That’s a bit risky: 77% of them state that they belong to the top 25% . It sounds like China’s GDP which grows, despite everything (SARS, Global crisis, environmental mayhem, people without retirement, half of the country without electricity and basic services, declining electricity consumption, riots in its muslim part, fear of Tiananmen celebrations…): a plain and so obvious lie that no one dares to ask a question. The kind of approach which produced interesting results (yes, Madoff – again!). The problem with lies is that sooner or later, they get to be discovered – and here, you cannot send the Chinese government in prison and look for the cash in their wives safes.
So what’s new under the sun of private equity? Well, the fact that as VC (in the US), (large/mega) LBO and probably funds of funds will show soon deceptive performances (to say the least), general partners are trying to sell us something else. What is it? BRICs! Follow my lead:
1. « US and Europe are in a mess» . Granted.
2. « Some countries are not: Brazil, China, India, Russia» . Errr… ok, let’s assume.
3. « They are young» (ok, discount Russia here, because actually it’s not true), « willing to consume» (we know where this has lead the world… but hey, we are talking about short term mess, not long term), « and gifted with purchasing power» (really? how? in monkey money? how can they consume when we are paying them like… Chinese/Indian workers? and what actually are they consuming? Expensive products from the West that even westerners cannot afford at the moment?)
4. « So, as we are in private equity, and great managers – top quartile, blah, blah, unrealized performance, blah, blah, fair market value, beurk, beurk, but glorious old days again, tagada, tagada… – we plan to go and colonize (financially) speaking these countries. Sign here, and wire the money on my private account.» True, it’s so much simpler than charging 2% per year (after all, you have to wait 10 years to get all the cash…)
Now, let’s imagine that it’s not your pension/insurance money which is at stake.
i) Russia and China are dictatorships
ii) Dictatorships have no problem to manipulate data
iii) Russia and Brazil ‘miracles’ rely on natural resources
iv) China and India do not address their social issues (poverty gap), nor their retirement and health issues
v) Culture in the four countries is radically different than in the US and Europe
vi) The fund managers talking to you are from US and Europe
vii) They are former investment bankers and consultants who have strongly contributed to create the mess in EU and the US
Do you still really want to invest with them in the BRICs?
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