A Princess for investors

If you are a sceptic, reasons for not investing in private equity are not difficult to come by. It’s an illiquid asset class, and investors are locked into investments for long periods of time. Minimum allocation requirements are high, transparency and reporting standards amongst managers relatively low. Picking the best funds takes one skill, gaining access to them another. Regulatory constraints, particularly in Europe, often mean that institutions are not allowed to take on the extra risk that private equity represents.

Investors who are nevertheless in the asset class have traditionally taken the view that the potential upside is significant enough to put up with the inconvencience that comes with it. But, as a small number of innovative fund managers have demonstrated, there are ways of investing in private equity which reduce or even eliminate many of the difficulties inherent in private equity investing.

Princess Private Equity Holding Limited is one such initiative. The Guernsey-based private equity fund of funds, jointly owned by Swiss Re and Zug-based Partners Group, manages $700m which it raised in cash in 1999 by way of issuing zero coupon convertible bonds that are listed at the Frankfurt and Luxembourg Stock Exchanges.

The bonds have a number of compelling characteristics. The capital guarantee by Swiss Re affords the bonds a AAA rating by Standard & Poor's. The listing removes the liquidity issue and the par value of $1,000, takes out the problem of high entry levels. Add to that a capital guarantee in the guise of an insurance policy reinsured by Swiss Re and protecting the par value of the bonds at maturity, and you’re looking at a risk-free security, making it particularly attractive to first-time investors in private equity.

Needless to say that such comfort has a price. On top of a 1.5 per cent management fee, Princess charges investors another 1.5 per cent insurance cover.

Says Stefan Schaechterle, general manager of Princess: “Products such as Princess may seem to be slightly more expensive than other private equity funds of funds. But people value the risk-free nature of the product as well as the immediate liquidity at exit, and so they’re willing to accept a relatively small moderation on expected returns.“

Schaechterle would not predict a specific level of return investors in Princess should be expecting. But he says the firm is very confident returns will be “much superior to what people can expect from allocations to conventional triple-A rated bonds.”

When it first came to market in 1999, the product proved highly popular with investors. “There was substantial appetite”, Schaechterle recalls. Around 80 per cent of the bonds were placed with institutional investors, mainly Swiss and German pension funds and insurance companies. The balance was sold to private investors.

Princess has a highly diversified investment approach, designed to generate superior returns at low risk. By March 2001, the fund’s investment managers – Partners Group, Hamilton Lane and Invesco – had invested 65 per cent of total assets in 96 private equity partnerships worldwide. 40 per cent of the funds went into buyouts, 40 per cent into venture capital and 20 per cent into special situations.

Whilst overall demand was high, the very broad investment mix wasn’t something that everyone was immediately comfortable with. “People said we didn’t know what we wanted to stick to,” Schaechterle says. “Did we want to do buyouts? Venture investments? Meanwhile we have seen our approach proved right.”

Schaechterle argues that what investors are now seeing is that Princess, because of its highly diversified allocation strategy, is able to offset a draught in one segment of private equity investment against gains made in another. “The cycles for buyouts and venture capital are not the same. We are currently in a low cycle for venture, but we are getting the benefits from our buyout portfolio that is now paying off.”

With hindsight being a wonderful thing, and given the extent of the current problems in venture capital, one might ask whether Princess would be doing better still if its exposure to venture funds was at a lower level. But Schaechterle disagrees: “I think the portfolio approach of Princess is perfect, and the portfolio itself is excellent.”

The numbers seem to verify this. By 31 March 2001, early on in its life cycle, Princess’s net asset value had increased to $720m.

Princess employs a risk/return model that takes into account performance data which has been collected from 1969 onwards. The firm aims to present a best of class selection of private equity firms and has invested in a long list of blue chip buyout, venture and specialist operators.

As demand for private equity in Europe grows, more institutions as well as retail investors will be looking to move into the asset class for the first time. A significant portion of this new appetite is likely to be absorbed by Princess-style products.