One of Europe’s largest asset managers, Scottish Widows Investment Partnership (SWIP) has a purview which extends across the entire spectrum of European private equity, and with a focus on buyout funds, they are expertly placed to comment on the turmoil buffeting the industry.
An 18-year veteran, William Gilmore, head of the private equity team at SWIP, is urging fund raising GPs to be realistic, both with themselves and with LPs, be they existing or prospective, and for all fund managers to embrace the idea of partnership with their investors, without whom, Gilmore says, they would not exist.
What is SWIP’s investment strategy?
In terms of geography we focus exclusively on Europe as that is where our expertise lies. Within Europe our focus is on buyout funds. We look at the wider definition of Europe, so our coverage includes Eastern Europe and we look at the wider definition of buyout funds, which includes turnaround funds, special situations, distressed debt and mezzanine.
How has the economic downturn affected the business?
We have seen the impact of the downturn in a number of different ways.
Firstly, the amount of capital that we will commit in 2009 will be substantially less than our normal run rate. This is not because we have less capital to invest, rather it reflects a shortage of relevant opportunities in the market. Very few of our favoured managers have chosen to fund raise in 2009 so we are happy to preserve capital until they are back in the market. Additionally we are wary of investing in funds that may not reach a viable size and hence be unable to execute their investment strategy and retain their staff. Given the shortage of new funds in the market we have spent time researching the turnaround and distressed debt spaces and are looking closely at secondaries.
Secondly, investment activity in the underlying funds is muted. There are few new deals being done and realisations are virtually non-existent. That said, I anticipate the pace of capital calls will increase over the next few months as existing deals are restructured.
Thirdly, we have seen a decline in the value of the portfolio that highlights just how correlated private equity and the stock market actually are.
Fourthly, we have seen some managers look to raise annex funds to support their existing portfolio. There can be good reasons for these, like making add-on acquisitions, or bad reasons, such as rescuing underperforming companies where the main fund has run out of money. There has also been an increase in recycling and fund extension requests.
Finally, I am pleased to say that we have not seen one of the negative impacts of the downturn that has hit other financial institutions, ie the need to sell assets at depressed valuations. As we have been conservative and are not over-committed we have not faced this situation.
How many private equity funds do you look at per year and how many do you invest in?
We tend to look at private equity in terms of a three-year cycle. Over a three year period we are looking to invest in around 30 funds from the 300 or so in our universe.
Our aim is to be appropriately but not over diversified. The diversification parameters that we consider include vintage year, geography, strategy, sector and enterprise value of the underlying companies.
We are flexible on an annual basis, that is to say that if we can’t find appropriate opportunities in 2009 we can be patient and wait until our funds of choice are available to invest in. We are not worried about missing out on 2009 vintage year funds as we still have substantial undrawn commitments to the funds we have backed over the last couple of years. These funds are well positioned to take advantage of the 2009-2011 investing window.
What tips would you give to GPs currently fund raising?
In a nutshell “be realistic”.
Firstly, GPs should obtain a good understanding of the level of support that they are likely to receive from their existing LPs – it may well be that some existing investors are happy with the GP but for their own internal reasons are not in a position to support the new fund. Prospective investors who are not existing LPs need to understand the reasons why existing LPs are not planning to re-up.
Secondly, GPs need to appreciate that the fund raising timescale is likely to be prolonged and they will need to be patient in helping investors with their due diligence and getting them over the line. This has resource implications for GPs and there is also a risk that GPs could have no capital to invest for an extended period of time.
Thirdly, consider carefully what the appropriate size of the fund should be to execute properly on the investment strategy and build a suitably diversified portfolio. While entry valuations may be lower, less debt is available and additional reserves are likely to be needed for follow-ons as holding period will be extended.
Fourthly, if the money is there, you should take it! By this I mean that it is better to have a modest first close as soon as possible. Many LPs won’t start looking at a fund in earnest until there has been a first close and the fund is for real. The corollary of this, of course, is that some LPs who are typical first close investors are nervous about committing to funds which may not become viable. Therefore GPs should be aware that conditional commitments are becoming more common.
Finally, be realistic on terms and conditions. Take soundings on what is acceptable before coming to market.
With leverage so hard to come by at the moment and the banks seemingly reluctant to return to the heady days of massive debt multiples and cov-lite loans, does it make LBO funds less attractive to you as an investor?
This certainly lessens the attraction of those funds which rely principally on financial engineering to create value.
We are more inclined to back funds that we believe have a sourcing advantage and which may be able to find off-market transactions at lower valuations. Also funds that have the ability to influence operationally the companies in which they invest and grow earnings are attractive. The ideal combination, we believe, is superior sourcing coupled with genuine operational value added. This in turn has led to a relative attraction of genuine sector specialist funds versus generalist funds.
What’s your stance on European venture capital?
European venture has never been a major feature of our portfolio and in recent years we have limited our exposure to selected re-ups with existing managers. We are certainly not looking to form new relationships in European venture.
The essential problem that I have with European venture is the time taken to create value. Quite understandably if you are looking to commercialise scientific technology that has been discovered in a university laboratory this takes many years. As such, early stage investments of this nature do not fit comfortably within the context of a 10-year fund structure. The problem is not so much the technology, as I think there is a strong scientific base in Europe, but the time taken to bring it to market and make an acceptable return. As capital is rationed, LPs have to allocate capital to those funds which they expect to produce high returns over a reasonable time frame. Against this background buyout funds look more attractive than venture funds for a typical LP.
The negative reputation of European VC is, I think, justified by the poor returns which it has delivered as an asset class. There are certainly a small number of high quality funds in Europe but the industry suffers from an excess of sub-scale funds which have performed poorly over the long term.
Only by consistently out-performing buyout funds of the same vintage will the European VC industry be able to change the negative perception that investors have of it.
What is your focus for the year ahead?
Over the next six months at least we expect the primary fund raising market to remain slow so I don’t see us making many new commitments in that time frame. If deal-doing activity does pick up we may see some of our favoured managers return to the market in the second half of 2010.
We are looking selectively at some secondary opportunities and it may well be that we deploy capital in this way in the coming months.
We are also looking to intensify our portfolio management activities by spending more time with our existing managers. Going forward we expect to work with fewer managers than we have historically so some tough decisions on whether or not we re-up with certain managers will require to be taken.
What issues do you think the private equity industry needs to be most concerned about in the coming months and years?
The biggest priority has to be the communication. GPs need to embrace the concept of partnership and communicate more frequently and effectively with their LPs, without whom they would not exist.
Many existing portfolio companies will need to be restructured and some will certainly fail. It is incumbent on GPs to communicate their reasons for deciding to support companies or let them fail as LPs will in turn have to provide these explanations to their clients whose capital is at risk.
More timeliness and transparency concerning the valuation process is also essential as LPs’ auditors are no longer willing to accept GPs’ valuations at face value. Consequently enhanced information flows from GP to LP are required.
William Gilmore, investment director, private equity
William is an investment director in the private equity team, which he heads, and is responsible for making investments in private equity funds globally. The private equity team manages more than €1.5bn in private equity commitments in over 60 fund investments. William is also a member of the advisory committees of a number of private equity funds, a director of the Private Equity Association and is regularly invited to speak at private equity conferences.
Prior to joining SWIP in October 2000, William worked for Murray Johnstone for 10 years, starting as an investment manager, before being appointed investment director for private equity. In 1994 he was appointed assistant fund manager of Murray Ventures.
Between 1987 and 1989, William was an investment accountant with Ivory & Sime, after spending four years with KPMG, where he qualified as a chartered accountant.
William holds a BA in accountancy and economics from the University of Strathclyde.
Scottish Widows Investment Partnership
Scottish Widows Investment Partnership (SWIP) is one of Europe’s largest asset management companies and part of the Lloyds Banking Group plc. Managing funds worth £82.7bn*, for a wide range of UK and international clients including individual investors, investment trusts, charities, financial institutions, corporate and local government pension funds. We are owned by our parent company Lloyds Banking Group, one of the UK’s leading financial services groups.
We invest in all major asset classes – including domestic and overseas equities, property, bonds and cash. In addition, we offer access to specialist areas such as multi-manager, smaller companies and socially responsible investment.
Under our own name and in partnership with local organisations, we have a presence that stretches from the United States to the Far East and includes Continental Europe. This international dimension heightens our awareness of global investment issues and enhances our ability to manage client relationships on a global basis.
The worldwide markets in which we invest, our international client base and the geographical spread of our business operations reflect the global nature of our business.
*Source: SWIP 30.06.2009