Appetite for disruption

The founder of Duke Street Capital, Edi Truell, is no longer a fan of private equity; at least not in the state the industry finds itself today.

Truell is not connected to Duke Street any more, having sold out of the London-headquartered mid-market firm in 2007. In his current incarnations he wears both LP and GP hats. On the LP side, he is still heavily involved in Pension Insurance Corporation (PIC), an insurer with investable assets of £4 billion (€4.5 billion; $6.5 billion) which he founded in 2006 with his brother Danny, the chief investment officer of UK charity (and formidable LP) The Wellcome Trust. On the GP side he has founded Disruptive Capital Partners, a management company which he hopes could “disrupt” the private equity market.

When we meet at PIC’s offices in the City of London, he is as strident as ever in his criticism of the private equity industry today. In particular, what has him fired up is the way in which most buyout groups conducted themselves during the nadir of the financial crisis. “There were wonderful opportunities to buy companies at great prices,” he says in his near-impeccable Queen’s English, “and with one or two honourable exceptions most private equity firms did not put a penny to work”.

To those in the industry, the fact that investment ground to a halt during 2009 is not news. In Europe, for example, the total value of private equity-backed buyout activity in 2009 just exceeded €20 billion, according to Nottingham University’s Centre for Management Buyout Research. In 2007 the equivalent figure had been nearly €180 billion.

PE’s missed opportunity

Truell continues that since he has raised these criticisms in a number of conference speeches, he has had a few arguments with large buyout professionals who took issue with his stance. The lack of available debt tends to top the list of reasons why investment levels plummeted, but he is unconvinced by the excuses. “At the end of the day, I personally acquired stakes in businesses at prices as low as 2.2 times EBITDA,” he says. “You don’t need debt if that is all you are paying.”

He drops the name of one of global private equity’s big guns into the conversation. “As I said to him the other day: ‘Did you not invest because you found that prices were too low?’”

Truell’s private equity career took off as the head of Hambro European Ventures. He subsequently spun the funds out to create Duke Street Capital. In 2000 he added a debt investment arm. In March 2007 he sold out of the private equity business, because by this time, he explains, private equity deals were becoming highly competitive, with people paying “silly prices” with too much debt.

Perhaps more significantly, he argues, the industry had also become “hidebound” and lacked the scope for opportunistic investment that had originally made it such an effective way to generate returns. Recalling the tail-end of his career at Duke Street, Truell says: “For example, I put together a deal to acquire 21 percent of the world’s crude oil tankers,” he says. “This is a cyclical market and this was right at the low point.” He did not have the backing of his partners at Duke Street, he says, as it was an asset deal rather than an operational deal. Limited partners had the same concerns. The deal did not go ahead.

“You couldn’t be opportunistic and you couldn’t be fast on your feet; this was what was at the origin of the private equity industry making money.” He compares the aborted oil tanker deal to the privatisation of train engines and carriages in the UK in the mid-‘90s. “At the time people weren’t so bloody prissy. If one could buy rolling stock from the government at a great price, one did. It made the fortunes of firms like Candover and Terra Firma.”

Referring again to low levels of investment activity during the downturn, says Truell: “It was to my mind a failure. You give money to private equity because it doesn’t suffer market volatility: it is not exposed to short-term pressures; it can take a long-term view. I think it is pathetic that a lot of the buyout groups did not invest when markets were utterly disrupted.” He goes on to explain that he personally made five investments “of substance” during the market turmoil, three of which have been realised. “The lowest IRR is about 80 percent; the highest IRR is about 400 percent,” he says.

Pensions and penguins

Having got out of private equity and debt management, Truell and his brother launched PIC  to capitalise on the


changes introduced by The Pensions Act 2004. Among other things the act stipulated that defined benefit pension fund sponsors – including general partners –  would be liable to make up for any shortfall in their funds and encouraged pension fund trustees to fund to a much higher level. As a result, many businesses with final salary pension schemes would be keen to get them off their balance sheet. PIC would be ready to buy these funds up, pool the assets and hopefully manage the assets and liabilities more effectively and profitably (see boxed item).

The views from PIC’s offices are impressive, looking down on the Bank of England with St. Paul’s Cathedral in the background. Penguins, which adorn the company’s logo, are ubiquitous: pictures on the walls, sculptures in the halls, even the meeting rooms are named after different penguin breeds – a reflection of Truell’s private passion for conservation projects.

His role at PIC has become less hands-on since founding the business. This fits with his assertion that he and his brother wanted to “do it the private equity way” in terms of setting up the business: “start with a strategic plan, get some wonderful board members in and start to fill the key slots in the management team”. Fittingly, an organisational chart of the company management shows the various divisional heads reporting into John Coomber, chief executive, while founder Truell floats alongside Coomber, unconnected to any party, but positioned to “sprinkle pixie dust”, as he calls it, where he can.

magic dust

The “pixie dust” tends to settle on the areas of deal origination, ongoing fundraising (“it is a capital absorbing business”) and asset management, particularly in regards to the 15 to 20 percent of the portfolio earmarked for high risk/high return alternatives. Of the group’s £4 billion portfolio, the bulk is “relatively dull”, says Truell, comprising government bonds and high-grade bonds. “But with that bedrock we can then do esoteric things with the other £400 million or so,” he says. There is nothing “in the middle”, he adds, meaning no public equities and very little property.

The “esoteric” portion of the portfolio is certainly that. The group recently formed a joint venture with the Middle Eastern sovereign wealth fund Qatari Investment Authority to put £250 million together to underwrite the risk of natural disasters, such as hurricanes and earthquakes. “You could ask why on earth we would be doing that when you have just seen a $100 billion loss in Japan and a very serious loss in New Zealand. But of course there is nothing like these massive high profile problems to boost demand for this sort of insurance. Demand is rocketing up.”

Elsewhere the group has been working with Permira’s debt team to invest in secondary CLO paper. Truell’s background, having set up Duke Street’s £4.4 billion debt management business which was sold to Babson Capital in 2004, means PIC can be “brave enough” to invest in complex products, as a small part of its well diversified portfolio. “We work with specialist managers to help us, but we keep a very keen interest ourselves,” he says.

What does this sizeable allocation to alternatives mean for Truell’s former peers in the world of private equity fund management? Not as much as they might hope.

“It would have been fairly hypocritical having sold out of Duke Street in March 2007 to then go and invest in private equity,” Truell says. “It would have seemed a bit weird.”

Straightforward commitments to primary private equity funds seem to be all but off the agenda. The secondaries market, however, is an area that is still of interest. For example, in 2009 PIC bought a relatively sizeable portfolio of secondary stakes in US venture capital funds: a deal advised by fund of funds manager Adveq. It has also committed to selected secondary funds and funds of funds.

Risk and regulation

PIC’s aversion to primary commitments is partly a function of risk and reward, but increasingly a function of regulation. The Solvency II directive, scheduled to be introduced in November of 2012, will introduce risk-based solvency requirements for insurance and re-insurance groups. Similar rules are being discussed with regards to pensions, and banks will likewise be affected by the upcoming Basel III rules.

What this means for insurers like PIC is that the amount of capital that needs to be set aside for private equity is significant. “And yet if you can buy an asset at a discount, that helps with the solvency calculation. That may sound like wonderland – it is wonderland – but that is the way it works,” says Truell.

He all but rules out committing to traditional blind pool private equity funds on the basis that cash for the commitment needs to be set aside and hence does not generate returns. “Since we are economically rational, we would much prefer to put capital to one side and earn a return on it rather than earn – as my banker recently put it – a cup of coffee,” he says.

Truell’s brother Danny has likewise been shifting The Wellcome Trust’s assets away from a private equity programme based only on primary fund commitments to one that has a greater focus on direct co-investment activity.

Despite his dissatisfaction with the industry as it looks today, Truell’s private equity roots have not, however, been totally severed.

“We are looking hard at how best to do growth capital,” he says, and harks back to an example from his time at Hambros. His team backed Mark Getty and Jonathan Klein to buy up and digitise image libraries. “We put up £12 million to digitise thousands of photographs initially onto CD. The key was to have the bravery and sense to buy lots of libraries. We completely disrupted that marketplace and Getty Images now dominates it.” It was not venture capital, he says, because they were not trying to invent new markets. “The image libraries were there and the advertisers were already buying images. We were just approaching it in a very – dare I say it – disruptive way,” he says.

Truell’s appetite for disruption has now manifested itself in the form of Disruptive Capital. His previous ventures – Duke Street, its debt management business and PIC – had all been built on the basis of seismic market disruption, he explains. “While we are about disrupting markets, why not disrupt the private equity markets at the same time.”

Disruptive influence

Disruptive comprises six professionals at its core and what Truell describes as a “cloud of angels” – a network of 40 or so operating partners who are invited in to help on deals as and when their experience proves most useful. An example of such an “angel” would be Peter Gangsted, a former Cinven board member who has known Truell since the two were 13-years-old. He was invited in to assist with an investment in Eco Plastics, having gained considerable experience in the plastic packaging arena during his time at Cinven.

Disruptive’s investors – predominantly family offices – commit capital on a deal-by-deal basis. There is no pledge fund, no committed capital and no ongoing fees. Truell points out that they have been able to finance all the deals they have wanted to do. “It means we can do a much wider variety of investments, ranging from growth capital to more classic buyouts,” he says.

Disruptive’s portfolio comprises the deals, referred to earlier, that Truell completed during the downturn. The focus is private equity investment, although last year the group underwrote a £24 million rights issue for an Irish listed pension administration company, allowing it to take over a rival.

While the deal-by-deal Disruptive model is one that suits Truell and his investors’ needs, there is a whole institutional private equity industry out there that needs to raise funds to survive. If a private equity poacher-turned-gamekeeper like Truell is shunning commitments to buyout funds, is there any hope? Will there be a bloodbath in 2011 as hundreds of firms try to raise new funds and find little LP appetite?

“It is going to be more of a whimper than a bloodbath,” Truell muses. Firms will retrospectively revise fundraising targets downwards, he says, and “there will be a lot of internecine fighting as it’s decided which partners go and which partners stay”.

Contributing to the hostile fundraising environment is the fact that a lot of the larger limited partners are making fewer and smaller fund commitments, in many cases because they are building up direct and co-investment capabilities. The thought of institutional investors – in particular forward-thinking sovereign wealth funds – upping their direct activity draws Truell back to his original complaint about the private equity industry.

“This is what annoys me,” he affirms. “The people who refinanced Citibank or Barclays [during the financial crisis] weren’t the private equity groups that were set up to do it. It was people like the Qataris doing it themselves … or Warren Buffet.”

“The richest pickings were left for other people,” he concludes, perhaps counting himself in that number.