PKA: ‘No hurdle? That’s crazy!’

Christian Kvorning, an investment director at the €31.5bn Danish pension fund’s alternatives arm, on worsening fund terms, the need for a ‘healthy crisis’ and elusive US managers.

PKA AIP, the dedicated alternative investment arm of the €31.5 billion Danish pension fund PKA, operates in arguably the most competitive part of the private equity market.

It is looking to invest in buyout funds of between $500 million and $2 billion. As such, although it does not have any geographical restrictions, it has historically invested by far the most actively in Western Europe and North America. It currently has around DKr42 billion ($6.2 billion; €5.7 billion) invested in private equity and a further DKr5.2 billion in infrastructure funds, according to PEI data.

Investment director Christian Kvorning explains to Private Equity International that, despite experiencing the biggest financial crisis since the 1930s, private equity fund terms have changed very little – in fact, for LPs, they’re getting progressively more challenging.

Q. Are global macro headwinds having an effect on PKA’s investment strategy?

A. To me it’s all about valuations. Valuations were cheap in 2002-04, those were great times for PE. They were cheap in 2009-11, those were great vintages. The other ones were overpriced. Cheap valuations give high returns, high valuations give low returns. It’s the same with any other asset. So let’s not get confused with macro or political noise, let’s look at fundamentals and valuations. Fundamentals drive long-term returns.

Q. Valuations are quite elevated in Europe at the moment. Do you expect them to cool off in the coming months?

A. I think they will come down at some point. Within a 10-year period there’s normally always a recession that nobody predicted, there’s a downturn that nobody saw coming, and it’s a complete surprise to everybody, every time. That typically drags down stock markets and private equity markets too. We had a downturn in ’01, and then one in 2008 and then the next one, I don’t know [when].

Q. How are you finding fund terms today?

A. Terms are tightening [with] some people dropping the hurdle rate completely. No hurdle? That’s crazy. In 2009-10, nobody could raise, and then in the fall of 2012 things started to change. Since then the GPs have been turning the screws on LPs. So key man [is] a bit worse, hurdle is an obvious one, fees. It’s still 1.75 percent on committed followed by 1.75 percent on invested capital. It’s still a hurdle, it’s still a 10 year fund, it’s still two one-year extensions. It’s exactly the same as it was for the last 20 years.

That LPs are unable to command better terms after the worst financial crisis of three generations, that’s pretty sad. We’re the LPs here and we’re looking after the local nurses and healthcare workers’ money, so we want low fees. And [there’s been] no material improvement. In fact, there’s been a worsening of terms, and bigger funds, and longer investment periods, and people hitting hard-caps in three or four months.

Q. How competitive is your segment of the market?

A. There is a bifurcation between perceived high-quality and low-quality, and there’s also another problem for us, which is the continued focus on the mid-market. A lot of people are also in that space. We don’t know how tough the competition is in [bigger] funds, because we’re not looking at those, I’m sure that’s crazy too. I can only speak for the $500 million to $2 billion range, and definitely competition is tough and we [see] funds close early.

Q. Is it difficult to get the allocations that you want?

A. Certainly. The other problem is AIFMD. American funds that are very good, let’s say their last fund was $500 million, they’re raising $600 million, existing US investors take the whole $600 million. They don’t call, they don’t market, they don’t come to Europe, they don’t contact us, we don’t know of them, they’re gone. That’s not a good situation. And that happens all the time.

[They’re] typically new mid-market funds that we haven’t found yet or that we have in our system as raising in 2017 and for some reason they’ve invested a bit faster and they’re out in 2016 and before we know it, it’s ‘first and final’, goodbye.

What we need is a good, healthy crisis to bring valuations down, to bring fundraising timelines out and to bring terms back in our favour. That would hurt our existing investments but it would be great for new investments.

Q. Many institutional investors are looking to decrease the number of manager relationships they have. Is it the same story at PKA?

A. We’re in the same boat. We have 100-plus funds in the portfolio, [which] is probably too many. We’re trying to put out pretty big cheques, ideally $75 million as a starting point, to fewer funds, and of course we try to back existing managers if we like them.

[What PKA is looking for is] big bite-sizes to fewer funds and where we bump our heads into the ceiling is if you go down in size in the mid-market to $500 million-$600 million and you want to do a $75 million-$100 million cheque, then you’re pretty soon 20 percent of the fund, and that’s quite a lot. We want the impossible, which is a very significant bite of a typically oversubscribed, mid-market, somewhat established fund. That’s the conundrum.