Going for growth

EVCJ: Could you explain MN Services’ strategy for private equity investment?

JvG: The strategy of MN Services on behalf of its clients is to build a global, well-diversified portfolio of top-tier private equity fund investments. Our target is to have an allocation to this asset class of 5% invested over time. A smaller allocation would not move the needle and therefore would not add value in a programme. We view private equity as a diversifier of the equity allocation. Within the global portfolio we allocate our capital opportunistically and view the quality of the management teams as crucial. The main distinction we make is for venture and growth capital versus the buyout/buy-in. For venture, our target is between 10% and 15% of total assets. Buyout, buy-in and special opportunities funds account for between 90% and 85%.

Our country allocation is between 35% and 60% for the US; 35% and 60% for Europe; and between 5% and 20% for the rest of world.

As the programme has been active since 1987, the majority of the allocation is skewed towards the US. Regarding the rest of the world, the majority is in Asia.

EVCJ: What is your due diligence procedure for fund investments?

JvG: We always start with a quick scan. For those funds we do believe might be of interest, we normally arrange a meeting at our office. Based on the outcome of such a meeting and some quick reference calls, we will decide if the fund manager would fit our programme. If the outcome is positive, we will do full due diligence.

We use a standard due diligence procedure for investments, whereby we focus on eight criteria. The main criteria are checking the personnel and the strength of the team; track record; investment strategy; deal flow; reference checking; risk/return characteristics; investment process; the fund structure and terms and finally we analyse any other funds in their portfolio.

The due diligence is done by the team, whereby we visit the fund and will have at least one day in their office with our team of at least two fund managers. In general we do request from the fund a full due diligence package. Most of the due diligence time is spent on team and track record.

To get a good idea of the track record we compare the funds with the public market and peer groups returns from internal and external database.

Our full due diligence procedure is an intensive process which takes about six to eight weeks by the team.

EVCJ: Where do you see the next hot sector?

JvG: There are a few hot sectors at the moment. First is the emerging markets, which is seen by many investors as the place to be. Although we have our concerns. Secondly, we are seeing a massive allocation towards infrastructure. But in our view this is more a credit game and less an equity one. Furthermore, we see it as a shift from government duties to private activities – more of a sale and leaseback from the Government.

I think mezzanine investment might become hot as the current fixed income cycle keeps on going. Also, the distressed sector might be a great opportunity going forward as default rates will increase in the down cycle. For sure, the appetite for secondaries will increase if we arrive at a down cycle in the economy. This will give great buying opportunities for those who are just starting out in private equity.

Venture will definitely make a comeback. The strong growth in China might result in higher prices and the upcoming down cycle will result in more demand for productivity improvements. Growth will be favoured as opposed to value. On top of this you will see a lot of activities in the clean energy space since environmental issues will continue to attract attention. Venture in Europe will get serious attention, however, in our view, will not reach US levels.

Sectors of interest going forward will be health and wellness since baby-boomers will be in a situation to spend more.

EVCJ: Do you also invest in direct deals and if so do you do co-investments?

JvG: Mn Services has, on behalf of its clients, made its first foray into co-investments with its direct funds. If the current market remains as it is and fee levels remain at the high end, co-investments should be an ideal proposition to reduce fees and enhance returns. Going forward, we will advise our clients to allocate more of their private equity allocation towards co-investments.

EVCJ: What are your views on the current investment environment and the credit crunch?

JvG: The current credit crunch might in the end result in changes in the fundamental investment approach. Credit risk will demand higher interest rates and more equity into a deal. As a result, current valuations might have to come down and leverage will be less limited. This will have a negative impact on the financial engineering players in the market. However, it will have less impact on the investors in growth capital and distressed deals. We do expect therefore returns to come down from existing investments. As in the current market where everybody has the excuse of being a 1998 or 1999 vintage and therefore generating a low return, we do expect to get the same comments about vintages in 2006 and 2007. Returns for the best funds will remain fair. However, the pooled average might return single digit returns.

Of course, going forward, 2008 and 2009 might become great vintage years, if the market suffers a serious setback right now. We, however, do not expect to get the golden age of the last cycle back soon. This would mean returns going back to the 20-year historic average, or even slightly lower. Being in private equity for over 20 years has taught us this is a cycle business, whereby you will see the movie again and again.

As we see in the hedge funds space where defaults are increasing, it might also be good to shakeout excess capital and firms from the private equity market going forward. This is a normal restructuring cycle. The big question, of course, during a possible down cycle will be the terms and conditions. Will LPs return to the driver’s seat, where they were in 2001 and 2002? And if so, will they use their power to make changes this time around, or will it again be business as usual?

EVCJ: What are your plans for the next year?

JvG: Our programme is a long-term one, whereby we allocate every year towards private equity. We will continue investing and allocating to private equity for the rest of 2007. However, there will be a limit on new relationships we will build with private equity firms. Our programme has become more mature and in order to avoid secondary transactions (indirect buying and selling of companies to ourselves) we plan to downscale our relationships with the fund managers.

Furthermore, in July, we acquired the assets of PME, the pension fund of Metal and Electronic, which has total assets of €21m. We will advise them to allocate towards private equity in line with our other clients. This might have a positive impact on the amount we have to allocate for the next year(s).