Five Questions with Ethan Vogelhut of Schroder Adveq

Schroder Adveq, a global asset manager, invests in U.S. small and middle-market buyouts through various strategies. Ethan Vogelhut, head of buyout investments Americas, spoke with Buyouts.

What kind of managers does Schroder invest with?

We invest in small- and middle-market buyouts because we believe they have better pricing and returns. We invest in primary, co-investment and secondaries strategies.

Every manager we invest in is a specialist in some area. They don’t have to be only industry experts but could be situational experts who invest in complex/complicated situations and have the capability of transforming a business. We also like highly operational fund managers.

A big part of our strategy is to back emerging managers and first funds if we think they will be market leaders of tomorrow.

We also back independent sponsors on specific projects; there is a real opportunity to align with the GP here because everything they do is on the line. They have to perform really well to be successful and you know they are working as hard as they can on the investment.

How do you view expanding fund sizes in lower and middle-market funds?

A lot of private equity groups have been successful because of a good market and many are getting very aggressive with their fund size. That creates a huge challenge for us as we try to understand what managers have earned the ‘right to grow’ as against those that are growing because of the market. The latter is not the best situation for future returns.

The increased fund size should not be just an asset-gathering exercise. Sometimes an increased fund size makes sense if the previous one was under-sized and lots of co-investments were used to invest the same amount of capital they are targeting now.

In some cases we want to see the team growing commensurate with the increase in the fund size. Else there are more portfolio companies to manage with existing team and that’s a red flag for us.

Increased fund sizes also mean the managers will write larger equity checks for larger companies. That is a different, more competitive and efficient market, and our concern is that the fund might change its strategy and be no longer relevant in our portfolio.

What makes you an investment partner of choice for co-investments?

A well-priced company with an identifiable transformational opportunity alongside a qualified GP with the skill set to execute that is the ideal co-investment opportunity for us.

That said, we see ourselves as strategic advisers that add value in addition to the capital; we make good investment partners for a couple of reasons. We have the capability and in-house teams to diligence the opportunity early and are very responsive to our GPs. We give GPs an understanding of the level of our interest and what the process looks like for us.

Importantly, because we have a large portfolio of companies and businesses, we can identify parallels between businesses and provide perspective to our GPs. Based on our wide experience, we help GPs identify risks in investments. We can also potentially make introductions to partners that are in the same business or have similar concerns.

How do you view the secondaries strategy evolving?

Investing in secondaries has evolved from acquiring LP positions in a portfolio company in the fund to acquiring interests in the whole GP fund. We think the next step in secondaries will be investing in fund restructurings.

We also think there will be an increase in co-investment opportunities in secondaries because of investor fatigue or because of liquidity constraints or because investors may not want to continue funding an investment.

Secondaries are almost 20 percent of all our investments and look for ‘under the radar’ opportunities that are not big enough for some of the larger secondary players to spend time on.

Apart from being differentiated in the lower and mid-market space we can underwrite any deal globally because of our reach.

What are some investment themes you are following this year?

We will continue to invest in small- and middle-market buyouts that we believe have better pricing and higher returns. We will also continue to focus on early-stage venture capital. Identifying emerging and new managers and independent managers to invest in continues to be important to us.

We also think theme-based investing, for instance healthcare and technology, will be popular in 2019. As we see it, healthcare is following the path of technology; people saw the potential in technology to change everything and wanted to be part of this secular trend.

Healthcare is such a large, inefficient market with so many parts to it. If you can partner with a specialist that understands different segments of the market you can create a more theme-based allocation to healthcare.

We are investing across the spectrum in healthcare – from early-stage funds focused on drug discoveries to PE funds focused on manufacturing and services for an aging population and backroom processes for cost savings.

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