Vancouver-based Nicola Wealth Management, which has the majority of its private equity exposure in fund of funds focused on Canadian mid-market buyouts and mezzanine debt, is looking to expand its asset pool beyond North America to invest in Europe and Asia. Kazuki Nohdomi tells Private Equity International about the firm’s plans to increase its commitment size to large investors, its concerns, and the benefits of keeping it local.
What are your plans for expansion going forward?
Generally larger commitments to our existing managers. In our fund investments, we’ve diversified across size, strategy (buy-out, capital growth, mezzanine debt), region, and I’m really excited about our line-up of managers. But clearly we need to always look for new ideas and strategies that would complement our existing line-up.
We also want to expand relationships to GPs in Europe and Asia within a couple of years. We need to pick our spots because overlap with our existing managers is something we should avoid. We will always be sensitive on fees so discounts, fee-breaks, management fees on invested capital as opposed to commitments, and access to direct co-investments are always welcome, but it’s a tricky balance.
Some of the Canadian PE funds I speak to have been getting some traction raising capital south of the border, often with larger institutions writing large checks. Returns have been good for the Canadian mid-market. The business cycle and a weaker Canadian dollar overall over the past five years I’m sure has helped returns both from translation gains on Canadian PE funds’ US portfolio companies, as well as from improvement in Canadian exports.
Competition in the Canadian PE space doesn’t seem extreme; valuations and leverage have looked more than reasonable overall. So for GPs, I would imagine re-ups with their existing Canadian LP-base would go pretty smoothly.
What are some of your biggest concerns in private equity as a Canadian LP?
One of the biggest concerns is how the increased oversight [by the SEC] is going to affect the talent pool in the longer term. If it’s going to increase costs and constrain returns hence compensation, it may at the margin push talent to other industries.
We’re also concerned about how carried interest gets taxed, and how that might impact the way private equity managers run future funds.
We are sensitive about fees and are vocal about getting access to direct co-investments to help bring down our average cost. From an absolute level, the 2/20 model is a concern for anyone because, in general, it’s expensive. We do our best to reduce the average cost for our fund by increasing our weight in direct co-investments, which are typically no-fee-no-carry.
The 2/20 model is relatively less flexible [for cutting costs]. So one way to average down our cost is through direct co-investments. As a firm we try to negotiate fees as aggressively as we can, where we can, regardless of asset class.
How do you pick your co-investments?
In general, we get better access to co-investments through smaller funds. We’ve participated as a co-investor in deals ranging from $10 million to $100 million in equity valuations. [Our] co-invests thus far have been mainly Canadian. We obviously need to manage that skew in the direct co-invest portion of our pie.
GPs are pretty strategic about who they let in [to the direct co-investments]. Size matters generally, i.e. larger LPs typically get the lion’s share. Which is understandable. Fortunately our target equity check for co-investments is small enough that some GPs will accommodate, and our commitment amounts are growing as our fund grows, so we are getting more access to direct co-investments.
While we do our own due diligence, a key part of our direct co-investment process is trusting our GPs. They have a good track record and we know they’ve done extensive diligence. So if they come across a deal that sits comfortably within their strategy and wheelhouse, and if it reduces our average cost, then why not?
For every dollar of commitment we make to a private equity fund, we like to see 60 to 70 cents of direct co-investing opportunities. We do not participate in all of them, we are selective. We need to obviously diversify and watch our exposures. Some institutions [larger LPs] have the resources and capacity to really do their own due diligence, whereas our approach is more about diversification and leveraging the work of our GPs. That allows us to bring down the cost for our fund. We would already get exposure to a portfolio company as an LP in a fund. To have a direct co-investment opportunity we can bring down our average cost, but obviously need to watch how much exposure we get to one particular company.
What is the PE community like in Vancouver?
It is a small community. Deal-flow and GP size naturally skew small. Returns, however, are healthy. For GPs, being on the ground and having established relationships I do think matter for deal flow. I would imagine a business owner wouldn’t say ‘no’ to a meeting with a large NY-based PE fund, but depending on the seller’s priorities, I’d like to think the seller would go with whom he/she knows and trusts.