The recent surge in LPs investing directly in private equity poses a threat to funds of funds managers, although investors should be beware that bringing direct investment decisions in-house is not as easy – or as economical – as it might seem, said Adveq CEO Sven Lidén, speaking exclusively to Private Equity International.
“What is probably the biggest risk we are facing is that [LPs] get so big they want to do it themselves,” Lidén said. “It’s probably something that goes in waves and cycles. We’re currently more in a cycle of people thinking about doing it themselves, trying to do it themselves. But it’s ultimately a difficult strategy.”
The reasons why it’s attractive are obvious, said Lidén, but the challenges can far outweigh the benefits. A major hurdle can be finding the right talent.
“You need really good people to execute direct deals, especially if you want to be in the lead. It’s one thing to be a co-investor, but it’s even more demanding like the Canadians to say ‘we take the lead on this: we’re buying the company, we’re changing the company’. You really need the best possible people,” Lidén said.
“Now the challenge with that is if you’re sitting in Canada where there’s not that much competition, it might work to keep the talent, and also the Canadian pension funds have been very generous with pay packages for these people, so they earn more than the prime minister. If in London you would try to build something like that, you’re more challenged because you’re competing with all the private equity houses who, for the top talent, would probably outbid you. Or you come to a salary level [where] basically it’s politically not acceptable anymore.”
Lidén argued that for young professionals in the industry today, the choice between working for a local authority pension fund in the UK or taking a role at a big buyout house with the potential to one day become partner is something of a no-brainer.
“I think there’s a risk of negative selection in the people that you get, and you can’t afford that if you want to do direct investment,” he said.
“Private equity is an industry which we think is difficult to execute, that’s why I think there’s a justification for this industry. If anybody could buy a company, make it a lot better and then sell it again, then you wouldn’t need an industry. And the fact that not even all private equity funds are successful but only some of them shows that actually it’s a very difficult strategy and you need really good people and a good structure to execute it. And I just think many of the institutional investors who are trying to do this on their own don’t have it.”
Adveq’s solution to the risk posed is to offer investors “things they can’t do themselves”, Lidén said.
Whereas many institutional investors believe they have the capabilities to make primary allocations without input from an intermediary, they may still need guidance on more complex transactions.
“We create a lot of alpha when we allocate to primaries too, but it’s very hard to prove that and it takes a long time,” Lidén said. “We have to prove our value more quickly, and that’s why we actually do secondaries, co-investments, staples and things like that, which for most of our even large clients, would be too complicated to execute.”
Look out for PEI’s full interview with Lidén, managing director and co-head of investment management Rainer Ender, and managing director and head of Europe Tim Creed in the November issue.