Guy Hands, chief investment officer and chairman of Terra Firma Capital Partners, believes the smaller end of the private equity industry will “start to return to its roots of 30 to 40 years ago” as the industry refocuses on “what investors really want”, according to an address he gave at the Super Return conference in Berlin this morning.
“When the industry began in the 1970s, it came out of club deals, which evolved into the first small private funds of the 1980s,” Hands said. “Back then two things were very different from today: deals were backed by a smaller number of investors, and the GP was expected to have a level of skin in the game that by today’s standards would be considered enormous.”
Hands said a GP commitment of 1 percent does not constitute alignment with investors, and that for many firms incentives are “out of line”.
He said the private equity industry will diverge along two paths, with large institutionalised players continuing to get larger and many becoming generalist asset managers, and others becoming “old style investment banks”.
On the smaller end, he believes GPs will become increasingly more specialist.
“The smaller GPs will focus on around twenty close LP relationships with a small group of LPs,” Hands said. “These GPs will put more skin in the game in order to build close relationships”.
Hands said the optimal size of funds was between €500 million and €2 billion, citing Terra Firma’s Special Opportunities Fund I, a £470 million vehicle, raised as a single asset fund to acquire Annington Homes from Nomura, which closed in December 2012, according to the firm’s website.
Terra Firma put 30 percent of the money into the fund itself, and the vehicle has achieved 2x in 3 years, Hands said.
“If I was investing in funds, I would put 50 percent into the largest 20 or so “me too” funds as they will give me beta and they are all pretty good. Then for alpha, I would focus on smaller firms.”
Earlier this month Hands announced that Terra Firma had committed capital of €1 billion for future deals. The firm will invest the capital on a deal-by-deal basis. Some of the capital could potentially also be committed to a future fund, PEI reported at the time.
“We are coming off the most successful period in our history in terms of money returned to our investors and profits made for them,” Hands said of the committed capital. “We have returned more than €6 billion to our investors over the last three years and produced cash profits for them in excess of €4 billion. And Terra Firma has been the biggest investor in its own funds so we have also done well from this.”
According to the Wall Street Journal, Hands later added that “more than 50 percent” of the €1 billion is his own money.
Investors, Hands said, want to know that GPs are driven by returns, rather than fees, and that the decision makers will also lose if an investment is unsuccessful.
“It means being more aligned with your investors, putting much more of your own skin in the game, giving them what they really want, minimising their fees, maximising their returns.”