Cracking the cocoon

Hamilton Lane has an insatiable appetite to capture, understand and benefit from marketplace information. This appetite extends all the way down to its office beverage-delivery systems.

Take Hamilton Lane's coffee maker, for example. Until recently, staff members were arriving at the Bala Cynwyd, Pennsylvania office at different times and, each seeking a fresh cup of coffee, were discarding carafes made earlier in the morning in favour of new brews. This, says chief investment officer Erik Hirsch, was inefficient and wasteful. “We were going through bags and bags of Starbucks,” Hirsch remarks. The firm replaced its coffee-pot regime with a cup-by- cup brewing system, which nicely aligned the interests of coffee drinkers and budget minders.

A soda pop market imbalance required more extensive analysis. Hamilton Lane's staff kitchen area features a coladispensing machine that, until recently, charged just 25 cents per can, thanks to a generous subsidy programme. But the machine was consistently empty, perplexing management. Further investigation revealed that droves of employees from other companies in the building were taking the elevator to Hamilton Lane's floor specifically to buy undervalued cans of soda. The private equity consultant now charges 50 cents per can and the scarcity of carbonated beverages in the office has largely been resolved.

But Hamilton Lane's professionals spend much more time scrutinising the vast amount of information that flows through the firm from private equity general and limited partners. This includes almost 600 private placement memoranda per year, all of which are tagged and scrutinised by Hirsch's nine-person investment team.

Having been in business now for 14 years, the firm also tracks the ebb and flow of roughly $32 billion (€26 billion) in capital through more than 500 private equity funds.

Mario Giannini, Hamilton Lane's chief executive officer, says the firm has been aggressively building out the infrastructure and personnel necessary to better analyse all the information it captures. The effort is in response to client demand. “People are tired of this asset class not being measured the way other asset classes are,” Giannini says, adding that private equity has existed in a “cocoon” of uniqueness, shielded from effective analysis by institutional investors.

In its mission to pry open the private equity cocoon, Hamilton Lane hopes to provide its clients with better advice and, where the advice is not heeded, to at least provide effective tools to measure an asset class that has traditionally resisted measurement.

THE PROCESS
General partners hopeful of getting an endorsement from Hamilton Lane can be assured of one thing – they will at the very least receive a thoughtful, polite, hand-signed rejection letter from the firm. Through an interactive database it calls the Investment Tracking System, Hamilton Lane's investment team carefully processes and tracks the hundreds of PPMs it gets sent each year by GPs hoping to secure capital commitments from the firm's 42 clients.

In July, for example, Hamilton Lane received 44 new PPMs, 16 of which fell under the “Domestic Venture Capital” strategy, according to a firm due diligence activity report. Nine were international buyout funds, five were domestic buyout funds, and the remainder were a smattering of international VC, special situation, mezzanine and real estate funds.

Each new PPM is assigned to an investment team member, who writes up a report after a basic screening. The reports end with one of two recommendations: “Decline this opportunity” or “Meet with the general partner”.

Typically, 150 to 200 GPs out of the roughly 600 hopefuls are given the chance to visit Bala Cynwyd for a due diligence meeting. In rare cases a Hamilton Lane team will travel for an initial meeting. The meetings are published in an internal forward calendar and open to anyone in the firm. New groups may meet with two to three staff members (there must be at least two Hamilton Lane professionals present). Fund managers to which Hamilton Lane clients already have committed capital may find themselves in a room with as many as 12 consultants.

This year through August, Hamilton Lane held 119 initial due diligence meetings with general partners.

Each meeting, which typically lasts an hour, results in a two- to three-page meeting-notes document, which, like the initial PPM screening notes, are reviewed at weekly investment committee meetings. The investment committee is six people, including Hamilton Lane chairman Les Brun. No one from Hamilton Lane's investment team sits on the investment committee.

Of the 150 to 200 initial meetings with GPs, 50 to 75 groups are selected for site visits, while the rest get friendly rejection letters. The site visit candidates are sent a hefty questionnaire in preparation of the next step in the due diligence process. All GPs must fill it out regardless of whether they have previously been through the Hamilton Lane process or not. Laughs Giannini: “I got an email from a group that is on Fund IV calling us anal retentive compulsives.”

Giannini claims the firm has recently turned down a Fund IV after having previously recommended several previous funds from the same GP group.

“Then it's planes, trains and automobiles,” says Hirsch. “If [the GP] is in Tokyo, we go to Tokyo. If they're in Connecticut, we go to Connecticut.”

Hamilton Lane's travel requirements are such that the firm has contracted with a travel agency to place one full-time agent inside the firm to coordinate the schedules of staff members and clients alike. For a recent site visit, Hirsch, three members of the investment team and four clients traveled to an East Coast city to kick the tyres of a fifth vehicle.

The site meetings result in one of two final reports: a thick one and a thin one. General partners should hope for the thick one, which delivers Hamilton Lane's official recommendation of a fund. This year through August, Hamilton Lane completed 35 site visits and recommended 25 funds. That's a 71 percent approval rate.

The final investment report, in addition to going through the GP backgrounds, strategy and terms of a particular offering, revalues every portfolio company using Hamilton Lane's own methodology. “The IRR we determine may be higher or it may be lower, but it won't match what's in the PPM,” says Hirsch.

Clients have access to any of Hamilton Lane's many reports on funds, and they don't always agree with what Hirsch and company have decided. While rejected GPs are encouraged to resubmit PPMs to the consultant for another crack at being recommended, Hamilton Lane has also revisited a prospectus at the urging of a client.

Says Giannini: “We've been wrong before. There was one fund on the West Coast that, on the first cut, we declined. But one of our clients said, “You know, I think you ought to have them come out and spend some more time on this.” So they did, and we did. We ended up investing with them and they've done great.”

This year through August, Hamilton Lane “rescreened” 18 funds.

Giannini says his firm's meticulous fund-tracking system allows it to better “scour the market” for opportunities, as well as to chart to what extent a fund is part of a wave of similar funds. For example, the firm has noticed that distressed debt funds, energy funds, mezzanine funds and certain regional funds arrive in cyclical bursts. Other bursts of fund offerings are better characterised as event-driven, such as the recent wave of “homeland security” funds.

QUANT JOCKEYS
During the reporting season, Hamilton Lane's voluminous mailroom resembles a small-town post office, as reports come in from hundreds of GP groups around the world. Giannini estimates that somewhere less than half of all GPs that have a relationship with the consultant rely solely on paper-based reporting.

Over the years, Hamilton Lane has captured an incredible amount of information on the private equity asset class as a good chunk of the industry's capital flow information passes through Bala Cynwyd. Hamilton Lane wants increasingly to be seen as a source of analysis, and has invested heavily in infrastructure and personnel to this end too.

The firm provides an online platform for clients to see their account activity, including capital calls, various forms of distributions, and capital account balances, which are adjusted each week. Two years ago, Hamilton Lane hired an engineering firm to take space in its offices and build the entire Portfolio Reporting System (PRS) from scratch. The firm has purchased no systems from outside vendors. “If someone has something that's better than ours, we'll buy it,” says Hirsch.

Giannini and Hirsch are most excited about their system's ability to “slice and dice” – allowing clients to analyse their respective portfolios in a way more familiar to public-market portfolio managers. This includes industry and sub-industry exposure charts, benchmarking against various indices, and the use of other measures such as Sharpe ratios. In this level of analysis, clients may use Hamilton Lane's universe of historic fund information, or they may also flow in supplemental data from Venture Economics and Cambridge Associates. Clients may export the data to Excel spreadsheets for more customised analysis.

Sharpe ratios and the like have been used to measure public markets and hedge fund performance, but many private equity insiders would argue that these gauges are of little use in truly understanding private equity. Hirsch says this type of exceptionalist thinking doesn't hold water at the institutional level. “Our clients tell us, “I cannot go in front of my board and tell them that [private equity] is just different,”” says Giannini. “Private equity is just too big for that. We're performing in a world that a public CIO is more familiar with.”

For more advance analysis, Hamilton Lane has hired a team of three researchers, led by Dr. Alex Cheung, a former economics lecturer at the University of Pennsylvania and experienced mutual fund and hedge fund analyst. Cheung's team runs Hamilton Lane's data through Matlab, an advanced software used by engineers and mathematicians.

“When we say “research,” we're not just talking about some guys reading about the markets,” says Hirsch of the firm's research team. “These guys are quant jockeys. They all have math degrees. They look at things differently than we do. I'll say something and they'll say, “Quantify that!””

Hirsch says among the more popular analyses run by Cheung's team is the creation of a “horizon model,” which estimates how much capital will need to be put out, and over how many years, for an investor to reach its desired allocation target.

GATES GOING FORWARD
With a new ownership structure in place, Hamilton Lane is rapidly expanding its operations and making a bet that institutions around the world will not only increasingly invest in private equity, but increasingly do so through firms like Hamilton Lane.

The firm currently has more than 60 people globally and plans to hire as many as ten more in the coming months, with partcular focus on increasing its back office and investment team lineup. The firm recently dispatched managing director Duke DeGrassi to London to further build the firm's presence in Europe. DeGrassi will hire about eight professionals there. In February it opened an office in Singapore. Back in Bala Cynwyd, the firm is preparing to lease additional office space at One Belmont Avenue's GSB Building now that every square foot of the ninth floor appears to be filled with Hamilton Lane employees.

The firm was founded in 1991 by Les Brun, the current chairman and still the largest individual shareholder in the business. Brun, a former investment banker who got his start in the financial industry working for Chemical Bank in South Korea, restructured his ownership last year to allow a new group of investors, including Bill Gates' family office and former CSFB co-head Hartley Rogers, to buy a 40 percent stake in Hamilton Lane. Credit Lyonnais retains a 24.9 percent stake. Crucially, the firm's professionals were allocated greater ownership in Hamilton Lane, a development welcomed by clients concerned over the defection in April 2003 of several employees led by Brad Atkins to form Franklin Park, a new private equity advisory firm that recently located to Bala Cynwyd (see this month's special feature story).

Hirsch describes the departures as having a minimal impact on his firm's operations. The many smaller investment advisory firms in the private equity space, he says, lack the wherewithal to compete in the big leagues with Hamilton Lane.