Plus ça change

Change is a dangerous word in private equity circles. Investors get jumpy at its mention – often taking it as a euphemism for style drift; probably as a result, most managers prefer to preserve the status quo. The principle also extends to the funds of funds community and in Switzerland, where investing in private equity took root earlier than other parts of Europe – thanks partly to the country's strong equity culture and historic money management tradition – change is a slow-burning process, but one that nonetheless appears to be taking place for a number of participants in the country's vigorous private equity fund of funds marketplace.

Victor Hugo once said: “Change your opinions, keep to your principles; change your leaves, keep to your roots” and that motto might well be applied to how Swiss fund of funds are, to varying degrees, subtly changing their offerings to take advantage of private equity investment opportunities that have now come to the fore in the European marketplace.

Despite the comparatively early exposure of many Swiss institutions to the asset class, a certain ambivalence still pervades their attitude to investing in private equity. Scarred by memories of what proved to be an ill-timed drive deeper into the tech and IT end of the asset class between 1999 and 2001 and, mindful of the demise of Swiss publicly quoted investment trust Private Equity Holding (sunk by aggressive leverage and an imploding portfolio), you might think that 2004/5 is too soon to declare a significant return to private equity by Swiss investors.

However, according to a new report initiated by long time Swiss fund of funds manager Adveq and carried out by researchers at the University of St Gallen, Swiss institutions may be looking at the asset class with fresh enthusiasm. The study, which canvassed the views of 100 Swiss asset managers with over CHF208 billion (€137 billion; $178 billion) of assets under management, discovered that less than 50 percent currently had a private equity allocation. However, the survey found that the number was set to increase from 44 percent to 56 percent (though no timescale was given). The survey also revealed that the average allocation to private equity would increase from 1.3 percent to 2.1 percent, suggesting that a total of around CHF2.5billion (€1.65 billion; $2.14 billion) could potentially go into the asset class from this group.

As Ralph Aerni, head of private equity at Swiss gatekeeper Strategic Capital Management (SCM), recounts: “Two years ago, if you called a Swiss pension fund, they didn't want to talk to you, they were having so many problems with public equity. Now, interest [in private equity] has picked up and although there is still a need to explain the industry drivers and educate investors about strategy execution, they're coming back slowly.”

David Chamberlain of Zurich-head quartered Palomar Capital Advisors concurs, declaring that, despite the confidence-jarring demise of Private Equity Holding and the 2001 bubble, Swiss investors will return to the marketplace: “Switzerland is an asset management community – the Swiss like to invent new products and be active in different asset classes. Swiss fund of funds are important vehicles for those institutions – and there are still a number of big institutions not yet committed to the asset class – to get exposure to this industry.”

If this is the case and Swiss institutional investors are set to commit significantly more capital to the asset class, it's worth taking a look at who the main beneficiaries might be and how a region famed for its product innovativion is changing its leaves, but keeping its roots.

One firm that knows all about change is Zurich-headquartered Alpha Associates. Established on April 1 2004, ten of the 12-strong firm came from Swiss Life (which had the task of restructuring Private Equity Holding) and Alpha continues to manage PEH today – which has been restructured and relaunched in the last 18 months with a new global venture portfolio strategy.

Swiss fund of funds are important vehicles for those institutions – and there are still a number of big institutions not yet committed to the asset class – to get exposure to this industry

David Chamberlain

The withdrawal of Swiss Life from the asset class allowed the new team, led by CEO Peter Derendinger, to reposition itself as a “thematic fund manager”. Having carried out what it describes as detailed macro-analysis, the firm has taken the decision to launch its newest €300 million vehicle, Alpha CEE 2005, with a specific focus on Central and Eastern Europe. Citing the Alpha team's experience in the region and the fact that penetration of private equity is still very low as a percentage of overall GDP there, Derendinger believes that: “The market is a bit like Spain and Portugal ten years ago. It's emerging market growth at developed market risk.”

Derendinger also believes that he and his team have learnt a great deal from restructuring the PEH portfolio, particularly when it comes to what it really means to be an active fund of funds manager. “A private equity portfolio can't be managed passively, which is what Swiss Life believed. Alpha believes in creating value by buying more of the good stuff and reducing exposure to disappointing managers,” says Derendinger.

With five dedicated professionals in its quantitative analysis team, Zugheadquartered Partners Group, constantly looks to buy more of that good stuff too. As befits a firm that was only set up in 1996, Partners also appreciates the value of a flexible approach, as evidenced by its readiness to explore new markets for its investment products. Most recently this has seen it develop a presence in Asia.

As co-chairman and partner Urs Wietlisbach says: “We've been looking at Asia for a number of years, but hadn't been happy with a number of factors including currency devaluations and the legal and regulatory environments. Now however, we felt the time was right to open an office there – GDP is improving, currencies are more stable and although there aren't as many tried and trusted managers there, we're convinced that, as a region, Asia will produce the best returns over the next decade.”

That belief and enthusiasm to grasp an opportunity when it comes along has led the group to not only set up an office in Singapore – led by partner Christoph Rubeli and staffed by two experienced local recruits – but also to launch a new fund of Asian funds this year. The fund has already held a first close on €50 million and has a final target of €150 – €200 million.

The approach adopted by Partners, which the firm describes as its “relative value approach”, has been in place since the firm won its first separate account mandate in 1998. Recounts Wietlisbach: “One of our separate accounts handed us €200 million and told us: “Do whatever you want with it. If you want 80 percent venture, fine. We'll look at you in five years” time and assess the results then.’” That somewhat intimidating mandate led the group to develop the relative value process, which involves the senior investment professionals in the firm sitting down every six months to assess the value drivers of a number of sub-asset classes within private equity and change allocation ratings to “over”, “under” or “neutral” as appropriate. Here's another instance of what it means to be an active FoF manager.

Accepting that the concept of active management can be more methodological than strategic, it's worth revisiting how Swiss FoF managers have been changing their approach to the asset class at this level too. Zurich-based Adveq is a case in point. Having built up a reputation as predominantly being an investor in venture funds, not only is European buyout occupying increasingly more of the firm's time, but managing director Bruno Raschle reckons there has been a “paradigm shift” in today's private equity marketplace that will create increased opportunities over the next few years: “On the technology side, everything is merging, but there will be significant structural changes occurring in mature markets especially. The buyout investment practice in particular will have to undergo dramatic changes in order to generate those returns investors are asking for in the future.”

This seems not to be a fundamental shift away from venture – the firm closed its most recent technology fund of funds PETP IV on $325 million in June this year – but rather an indication that as an investment manager, the firms needs to have the inhouse capacity to address changes imposed by global dynamics. That subtle change in emphasis is predicated on Raschle's firmly held belief that every fund manager is a trustee and, as such, must act in the best interest of its investors including the delivery of returns in cash instead of unrealised numbers : “We don't sell products. We sell competence on a principal – principal level, based on longterm expectation. The worst thing you can do to a Swiss banker is not pay back your debt. The worst thing you can do to a Swiss institutional investor is lose his money.” (Some might add that it's not just a Swiss investor who feels this way).

Having, as Raschle puts it, “quietly raised $0.5 billion in 2001/2”, the firm is planning to launch its third pan- European buyout-centric fund of funds in early 2005. The size has not been finalised yet, but Raschle believes that it's vital to avoid any temptation to raise as much as one can instead of what one can manage. Closing the fund will be all about discipline. “It will be important to stay firm and we can do that only if we are independent, practise strong governance and believe in trusteeship.”

Adveq's decision to steer clear of the secondaries market – as Raschle puts it: “We had the opportunity to build a secondary platform last year, but said no” – is in marked contrast to a number of Swiss managers looking to offer a variety of alternative investment products to their investors. Not only has Partners Group launched an Asian FoF, but they also closed Partners Group Secondary LP, the firm's first dedicated secondary vehicle, on €500 million in September. And LGT Capital Partners – one of the heavyweights in the FoF industry – has allocated up to 25 percent of its most recent vehicle, Crown Private Equity European Buyout Opportunities to purchasing secondary interests. The fund closed in August on €392 million.

But perhaps the most interesting development in the Swiss marketplace during 2004 was the decision of David Chamberlain, the respected head of private equity alternative asset manager Unigestion, to leave the firm after 16 years to spearhead a new advisory and placement service specifically targeting secondary private equity interests at Palomar Capital Advisors.

Following an early initiation into the secondaries market through managing a secondary fund of funds for Unigestion launched in 1999, Chamberlain says that he became increasingly aware of how secondaries could be used to manage portfolio construction: “I think we're now at the first stage of real maturity in the European private equity market. Investors have been in the market for ten years or so now and they know that they need to manage their portfolios more constructively.”

Chamberlain believes that while, on the one hand, the market is maturing in that when an investor sells or looks to replace a certain position, there is no automatic assumption that they are “giving up on the asset class”, there is still a considerable lack of awareness of the mechanics of disposing of an interest: “Most institutions don't know how to sell a position. When they do, they think only of the big, main players and don't immediately think of other European institutions who may be interested in taking up such a position.”

However, it isn't just European investors being targeted by Swiss funds of funds. As part of its continued investment activities in the US, LGT Capital Partners took the step within the last 12 months of opening a New York office. Historically, the Pföffikon-headquartered firm raised all its capital from European investors, but in raising its most recent Crown Private Equity European Buyout Opportunities fund, the firm successfully went Stateside for the first time. According to partner Ivan Vercoutère: “We could have raised the entire fund in Europe, but we decided to take the first steps to diversify our investor base and received commitments from a number of endowments and foundations in the US.”

Another Swiss investment manager that has forged a presence in the US is Swiss Re Private Equity Advisers (Swiss Re PEA), which has an established office in New York. Swiss Re PEA aims to have two offices of equal size and already commits more than 50 percent of its funds in the US.

With its four portfolio funds between 50 and 80 percent invested, the Swiss Re PEA team are likely to be fundraising in 2005, according to head of the fund of funds team Harold Weiss. Weiss cites the backing of (Standard & Poor AA-rated) Swiss Re, whose €200 million commitment was cornerstone to the firm's latest €409 million fund of funds closed in March, as a key factor that opens up access to top quality funds for the group. Prudence is also clearly an important fund raising message for Weiss just as it was for Adveq's Raschle amongst others. As Weiss says: “We will only raise appropriate fund sizes for appropriate investment opportunities; fund sizes that allow us to deploy the money wisely.”

The worst thing you can do to a Swiss banker is not pay back your debt. The worst thing you can do to a Swiss institutional investor is lose his money

Bruno Raschle

The increasing amount of liquidity in the marketplace, evidenced by the return of Swiss investors and the increasing attention of US institutions on the European buyout marketplace, clearly is regarded as a double-edged sword. Although no one will declare a buyout bubble there is nonetheless the sense that there is a great deal of capital arriving in this segment of the asset class – and much is trained on Europe. Comments LGT's Vercoutère: “I don't want to spook the marketplace, but the European buyout market in 2004/5 smells a bit like the VC market in 1999/2000. Discipline is holding but if all the funds coming to market next year get funded, then we could see a problem with pricing and ultimately returns.”

Looking upstream, Swiss Re PEA's Weiss believes that, while there may be numerous fund managers raising capital in the next 18 months, equally there are a significant number of institutions who will be keen to get a slice of the action: “There are still a number of institutional investors who are underexposed to the asset class. There are limited ways for them to deploy their capital and they are looking to private equity as an asset class that can deliver alpha returns.”

Zurich-headquartered Strategic Capital Management (SCM) provides further evidence of the winds of change that have blown through the Swiss private equity investment community. In April, the firm appointed Ralph Aerni as head of the firm's private equity team and co-head of the firm's real estate groups. Aerni will manage the groups with Stefan Hepp, CEO and founding partner, who will continue to focus on the firm's client relations and business development. SCM terminated its non-core listed equity business during Q1 2004 in order to focus on its core private equity advisory services as well as expand its real estate advisory business. The firm continues to manage a fund of funds raised in 988 and will raise its second invitation-only fund of funds in the near future. Any such product would, like its predecessor, pool assets from existing SCM clients and would not be widely marketed.

Clearly gate keeping provides a sufficiently compelling model for SCM – in Aerni's words: “We are a traditional gatekeeper, committed to extensive due diligence and a meaningful sharing of know-how with our clients; we are dedicated to the management of tailormade investment programmes that reflect the investment goals of each client.” Which sounds like a commitment to the bespoke rather than the general – aka mainstream – FoF product. And so it proves. Aerni on the SCM model again: “This excludes the marketing of fund of funds products that target a broad investment audience by reflecting the largest common denominator possible.”

I don't want to spook the marketplace, but the European buyout market in 2004/5 smells a bit like the VC market in 1999/2000. Discipline is holding but if all the funds coming to market next year get funded, then I think there will be a problem with pricing and ultimately returns

Ivan Vercoutère

SCM, like many of the players in the Swiss private equity industry is refusing to stand still. Seemingly, the one constant in the marketplace is the fact that change is essential in order not just to be successful but also to grow. Change is coming slowly in some cases, subtly in a lot of cases, but coming nonetheless. And it's not as if this community is all jumping on a bandwagon either; firms are looking at their own business models and developing distinct new strategies – be that moving into Asia, the US, developing a secondaries offering or focussing on particular segments of the asset class. 2004 has been a year of significant, but understated, change for the private equity money managers of Switzerland. Despite some recent trials for private equity investors in the country, the roots of the asset class' investment management industry remain in good shape.

While there may have been a significant number of directional, positional and attitudinal changes within the Swiss fund of funds community, among the buyout groups, it's been pretty much business as usual in 2004. As one player in the marketplace summed up: “Switzerland is not a closed community, but it is a tiny country. There are normally two or three mid-market buyouts here a year and the trick is to have a strong network within the Swiss business community.”

One of the firms with an established network is Zurichheadquartered CapVis Partners, which completed its third acquisition of the year by buying chemical company SFChem AG for CHF81 million (€52 million; $65 million) in September. The firm also acquired ABB Building Systems earlier in the year – a deal that brought private equity in Switzerland into the spotlight given the profile of the vendor. Comments CapVis partner Rolf Friedli: “ABB is a household name in Switzerland, so that deal attracted a lot of attention. The perception of private equity is changing here, particularly amongst owners of private companies looking to sell. If there are no trade buyers, private equity is increasingly viewed as a feasible alternative.”

Reflecting on other sources of dealflow in the Swiss market, Friedli feels that the wave of corporate restructurings among big corporations that took place between 2000 and 2002 “is pretty much over now”. Some opportunities arise from succession issues in smaller private companies, which he says “has been a topic for the last 20 years – and always will be”. Although CapVis will continue to focus on its home market, amidst relatively limited competition according to Friedli, the firm will also broaden its outlook: “The economic landscapes of Southern Germany and Switzerland are quite similar now, so we are seeing some opportunities there.”

Concurring with this point is director at international buyout firm 3i, Michael Petersen, whose firm's pan-European approach means that: “Although I work in Zurich and my heart lies in Switzerland, we work all over Europe and collaborate closely with the other offices.” 3i has completed two deals in Switzerland in the last 12 months with the midmarket buyout of Siemens spin-off MIB AG Property & Financial Management and a recent undisclosed growth capital investment in advertising marketer company Goldblach Media AG. On the competition front Petersen thinks that things have changed quite significantly in the last 12 months: “Trade buyers, who were largely inactive during 2002/3 are back, sometimes paying aggressive prices for assets. In terms of competition from financial sponsors, the main increase has been in firms from abroad, sometimes lowering their deal size and coming in for smaller deals.”

One such transaction this year was the acquisition in July of Eismann, where German group ECM Capital Management and Dutch private equity firm Parcom Ventures acquired the division of Swiss conglomerate Nestlé for an undisclosed sum. And when KKR decided to sell its Swiss metering firm Landis & Gyr, also in July, it was Australian energy company Bayard Energy who stepped up.

Further evidence of the influx of non-domestic buyout groups came when London-based Stirling Square Capital Partners acquired Swiss thin film surface technology company Ionbond Group from Saurer AG. Discussing how the deal came about through the firm's network of European personal contacts, partner Martin Calderbank explained the appeal of the region to the firm: “The Swiss market is extremely attractive to us, given our international reach and aspirations. We look forward to doing more deals there in the future.” Adds fellow partner Jakob Förschner: “A local business will frequently go local. But if the management team has an international approach, they often look further afield, which is where we can help.”

Within Switzerland, Leman Capital continues to go quietly about its business. The firm has chosen to temporarily halt the raising of its second fund after a first close on €130 million (in August 2002) in order to concentrate on realising exits – such as its recent sale of clothes retailer Guy Laroche for $17 million. The firm has also completed two investments from the second fund in engineering firm Bontaz Centre and watchcase maker Guillod-Gunther.

Leman partner Christophe Borer, believes that dealflow in the mid-market sector is picking up: “Strategic moves are back on the agenda. After a couple of years managing through the downturn, companies are more willing to talk about exits and succession issues.” While Borer agrees with CapVis' Friedli that the corporate restructuring side of the market is slowing down, he believes there are still a few opportunities in the sector: “It's not so much about distressed assets any more; it's more about strategic thinking, rather than the urgency of cash crises.”

The one thing that all the buyout firms PEI spoke to agreed on was that in future, as more money comes into the asset class and investors are scrutinising both returns and performance, they will be benchmarked against not just fellow Swiss managers, but increasingly against pan- European and US buyout houses too. There may be plenty to do but there's also plenty to prove.

It might be tempting to think that following the well-documented, high profile fall from grace of Private Equity Holding (PEH), other Swiss-listed private equity vehicles might be well-advised to play down any similarities between themselves and that particular quoted investment trust.

PEH, now under the stewardship of Peter Derendinger and his new firm Alpha Associates, has stabilised its balance sheet, reduced its outstanding capital commitments by 90 percent and has also made its first new venture investment under a new global venture portfolio strategy. However, the sour taste left in the mouths of investors and the hundreds of negative column inches devoted to the demise of PEH by a largely hostile domestic press undoubtedly had an impact. Not only did the Swiss private equity industry as a whole find itself being closely scrutinised and questioned – an experience from which it is still recovering according to some observers – but also other private equity vehicles that had elected to list on the Swiss public market were put under the spotlight too.

Assessing the impact of the PEH demise, Benedickt Brenninkmeijer, CEO of listed vehicle shaPE Capital remarks: “The market was traumatised and still is a bit. PEH was the largest vehicle at the time and the most bullish in its marketing and with the words “private equity” in its name, it was a negative association with something that went so wrong.”

Brenninkmeijer believes that one reason why listed vehicles are so popular in Switzerland is because the private banking industry is an important source of capital and its private clients need liquidity. Listed vehicles give them just that. And that is why, in September 2001, Bank Julius Baer set up a listed private equity fund of funds vehicle for private clients to gain exposure to the asset class. The new product, shaPE Capital, was launched with an IPO in November 2001, raising CHF137 million (€90 million; $116 million).

The listed vehicle, which is guided by external investment adviser Robeco Asset Management, began investing in 2002 and is approaching the end of its initial investment phase. Brenninkmeijer is all too aware that the attitudes of some fund managers will change as his vehicle moves into the more management-oriented phase of its lifespan: “As evergreen structures, listed funds of funds can appear less attractive to GPs because they are aware that our annual commitment will go down.”

Brenninkmeijer is nonetheless confident of shaPE's upside: for one, its buying power is increased through its association with Robeco. He is confident about the firm's ability to deploy capital into top-quality funds: “I wouldn't lie awake if I didn't get into a particular limited partnership [through being a listed vehicle]. If we don't get into one fund, we'll get into another top performing one.” With investments secured in Permira III, Cinven III, Swander Pace Capital III and Bain Capital VI Coinvestment Fund, Brenninkmeijer's confidence does not seem misplaced.

Proof can also be found in the performance statistics. Along with AIG Private Equity, shaPE leads the way according to the data provided by LPX, the private equity stock index that monitors the performance of listed private equity companies against the average of the top performing 50 such vehicles (see chart below). These two vehicles rank first and second among their Swiss competitors and, in outlining the difference with the competition, two members of AIG Private Equity's management committee, Conradin Schneider and Andrew Fletcher, extol the contrasting virtues of the heft of the AIG global presence behind them and the leanness of their own streamlined operation.

Domiciled in Zug, the AIG Private Equity team is five-strong and outsources accountancy matters to firms in New York and Switzerland. Investment management and due diligence processes go to the private equity group within global insurance and financial services giant AIG. “The name association and backing of AIG is undoubtedly helpful when dealing with GPs,” says Fletcher. Aside from that backing and the trimness of the Zug office, Schneider believes that the group's ability and willingness to co-invest and make direct investments has also been a contributing factor in an increase in the firm's share price of almost 20 percent in the year to 30 September 2004 – alongside an increase in net asset value of 13 percent in the same period.

The imposed burdens on Swiss listed funds of funds – coming out of the shadow of PEH; the extra fee layer involved; difficulties in maintaining a balanced portfolio and enhanced reporting requirements – may seem onerous, but for AIG and shaPE, the advantages are outstripping the difficulties. There's clearly still demand for the right product.