What is Altius’ strategy for investment in private equity funds?
Our strategy is one of proactive identification of the best managers in each space and adopting a truly disciplined approach to portfolio construction. Everybody in our market is pursuing the same goal of finding the top performing managers, and there will be a degree of common ground between advisors and fund-of-funds managers. However, Altius’ view is that investors need to be disciplined and to focus on the selection and concentration of the superior managers. We want to ensure that our clients are not buying the whole market. This is key to maximizing the out-performance impact of those top managers on the portfolio. Altius’ disciplined approach means that we will not automatically commit to, what are, by all accounts considered to be ‘good’ groups if we feel there are better opportunities. To affect this approach we have to identify our ‘better opportunity’ target managers early and work hard and proactively with these managers to secure meaningful allocations. It would arguably be easier to build larger over-diversified portfolios, seeking more modest allocations from a larger number of above average opportunities. We would still have portfolios that included the best managers, but this would not be maximizing the contribution that our client’s private equity programmes make to their wider and already well-diversified asset portfolios.
Have there been any legal or cultural obstacles, which have held you back when doing investments?
A few years back we experienced a number of tax-related legal issues that caused problems, and ultimately in a couple of instances frustrated investments. Some of these issues could be described as industry growing pains as domestic managers in continental European countries started to accept foreign investors. Unfortunately the legislation in various jurisdictions was not yet in place to facilitate this. Today these types of issues have largely been resolved.
More recently, working with US pension funds, the implications of the Freedom of Information Act (FOIA) laws created additional work. At the extreme, the market witnessed a handful of US venture managers excluding existing and potential investors subject to such laws. As far as Altius is concerned, in California, Maryland and Texas (states where we have clients) domestic legislation has been clarified, and broadly speaking requires top-line performance disclosure which fund managers should be, and generally are, comfortable with. With every investment made there is a legal process to go through, it is often more protracted with public entities, but there are sound reasons behind the additional requirements and we work efficiently through the process. A purely legal obstacle would be a rare exception today given our current client base of institutional pension funds.
Culturally, Altius has not been held back at all, quite the reverse. Private equity is an international business and we benefit from a team made up of individuals covering a wide range of nationalities, work experience and cultural backgrounds, with the majority of the European staff being multi-lingual, half being non UK nationals.
What, in your view, are the most important characteristics for a good fund manager?
We are purely focused on private equity and so we are looking for those managers who will, on a risk-adjusted basis, out-perform in the asset class. There are a number of characteristics that we believe can create a superior performer and will likely be a combination, of the team, strategy and sector, approach and competitive environment. It is difficult to be more specific as each investment case is different, with emphasis on different aspects. In general we tend to back proven teams in proven sectors with as strong an alignment of interest with our investors as possible. We also tend to favor managers who make a demonstrable impact on the value creation process, though we have to be realistic about the genuine ‘value-added.’
What size investments do you make?
Commitments that we advise on across clients to a single fund manager range enormously. They could be anywhere between €5m and €500m. This is a result of the diversity in the size of our clients’ portfolios.
How do you assess the risks associated with firms you have never dealt with before?
Broadly we would assess them on the same basis that we do firms already known to us. Firms will be new to us typically because they are either new to the market space, have previously been in a captive situation and not open to external investors or are a spinout team. Consequently ‘new to Altius’ funds tend to have risks associated with changes in strategy, influential incumbent cornerstone investors or risks surrounding new team build-ups. If the investment proposition has a genuine niche or compelling competitive advantage and the additional risks are well managed then we have no principal objection to doing new funds. Alignment is often strong in such circumstances, as team executives may have the experience but have not benefited historically from investing a fund with as beneficial economic incentives. In reality though, we complete only a small minority of such opportunities. The risks tend to hold up and the presented ‘compelling competitive advantages’, ‘niches’ or ‘unique investment propositions’ are often neither unique nor compelling.
How do you put together your investment portfolio?
The priority is ensuring that we have a focused portfolio of top quality managers and then ensuring that we have achieved sufficient geographic, vintage and sector diversification.
We put together a portfolio plan at the outset, and it typically looks forward five years. This is then updated regularly. This forms the core of the portfolio. Although obviously there is flexibility and we add new relationships or replace existing ones as necessary. We will not take a positive view in a particular sub-sector if the identified opportunity is not of comparable merit to others across the whole asset class. To this extent the portfolios are largely created bottom-up. We work with our clients on a one-to-one basis and all have independent portfolios. This allows us to create a portfolio that fits their objectives more closely.
How would you describe the investment environment for institutional investors in private equity today?
The most common complaint I hear is from those lamenting the growing capital that is pouring into the asset class. Market commentators report increasing difficulty for institutional investors in achieving access to the quality funds. Both characteristics of the market are true but to treat one as the result of the other in isolation is simplistic. There are more factors at work. Private equity is not an asset class that on average out-performs stock markets, it is only the wide dispersion of returns and the ability to select the best performers that provides any true out-performance. So I expect all funds we target to be oversubscribed, even with no new capital in the market. Withstanding this, and given that there is an increase in capital in the market, access while remaining a challenge is not as impossible as the numbers would suggest. The reason for this is another equally important factor; the asset class is now offering an increasing supply of opportunity. Large buyout managers are creating their own market from the alternative corporate governance model they are offering to public markets, and there seems little limit to potential fund sizes or the ambitions of the larger teams to deploy capital. Whether it is efficiently priced for the longer term only time (returns and supply of capital) will tell. But I believe it has proved itself to investors as an established and worthy alternative for the foreseeable future. The large market expansion and the tendency for successful managers to progress fund-on-fund to larger vehicles and to target larger investments also continues to create dynamics and opportunity lower down the scale for small and mid-market fund managers. This is all good news for investors in the asset class.
On top of this growth, there is improved liquidity (or perhaps more aptly less illiquidity.) Improved liquidity for general partners is provided in the form of acquiescent debt markets and unprecedented levels of secondary transactions. Meanwhile quicker returns of capital from managers and the growing secondary LP markets are in turn providing a more liquid investment class for the institutional investor.
What are Altius’ plans for investing in private equity in the next year?
We will continue to implement the portfolio plans assembled for our clients, and continue to work and build relationships with those managers who we believe are best equipped to out-perform their peers. There are no radical changes envisaged to our systematic and disciplined approach.