Privately Speaking: Adveq's firm on fees

At first glance, Adveq’s low-key Zurich headquarters may not seem to be ideally situated. Located in the city’s northern-most district, there’s no dreamy view of the lake or the mountains or the church spires.

However, at a mere six-minute train ride from the city’s airport, as managing director and co-head of investment management Rainer Ender points out to Private Equity International, the firm has the advantage of being either the first or last stop for investors and fund managers visiting the city. Adveq directors can leave the office at 7am and be in central London before nine. Picturesque it isn’t, but efficient it most certainly is.

While some funds of funds of old are barely recognisable today, having morphed into “funds platforms”, “asset managers” and “alternative investment specialists”, Adveq’s journey from fund of funds to a specialised private equity provider has been more of an evolution than a transformation.

The firm launched in 1997 with its technology programme, focused predominantly on venture investments, followed a year later by Adveq Europe, which invested in everything from large buyouts to specialised small buyouts to venture capital. In 2005, the firm launched Adveq Opportunity, focused on small and mid-sized turnaround and small buyout opportunities in the US, and a year later launched Adveq Asia.

Secondaries followed in 2009, a real assets programme focused on natural resources came in 2011, and in 2014 the firm began raising a dedicated co-investment fund.

Having started as a pure fund of funds player, albeit with the capacity to make co-investments and secondaries transactions, since 2009 on average 40 percent of Adveq’s commitments have been “transactional investments” – secondaries, co-investments, stapled transactions, club funds and “late primaries”.

Adveq has also taken on a number of single-client mandates, today looking after 10, among them the London Pensions Fund Authority’s co-investment programme.

“When I joined we hardly had any mandates. In the last three years they’ve been 40 percent of our business,” says CEO and head of investor relations and marketing Sven Lidén. “The switch is really to customised mandates where clients define what they want and we try to provide them with that.”

These mandates tend to be discretionary, which is “relatively special in the industry”, Lidén says.

“Our point has always been to have mandates where we still have the discretion, so that people basically get the same exposure [as investors in the co-mingled funds].”
Most of these mandates look to invest globally across primaries, secondaries and co-investments, thereby limiting the potential for conflicts.

“As long as they’re complementary and not competing for the same capacity, the capacity’s very large,” Lidén says of the potential to accommodate more mandates. “Before we accept a mandate we always see that we have sufficient capacity.”

DANGEROUS TREND

Although the firm has certainly evolved, Lidén sees a danger in straying too far from what it knows best.

“What we see in the industry today, which I think is a dangerous trend, is that everybody tries to diversify away from private equity. Be it because infrastructure looks so attractive, be it because the loan market looks so cool right now and everybody wants to put their money into loans, so they’re trying to diversify their core offering. And I just think that’s a risk.”

Adveq’s clients run the gamut of private equity investors, from first-timers who use the intermediary as their only investment in private equity to highly experienced investors with broad and deep private equity portfolios.

“Historically funds of funds were always the entry to private equity,” Lidén says. “What we see today is a better mix of clients. We obviously still have the people who do their first private equity commitment, that is still a popular way to approach us, but I think what we more and more see – and that’s what we do with endowments for example – they typically do large private equity programmes themselves, but they outsource certain things they cannot do themselves.”

Offering clients that which they cannot do themselves has to be Adveq’s business proposition in order to stay relevant, Lidén says. This includes strategies more “at the work-intensive end of the spectrum”, says Tim Creed, managing director and head of the firm’s European programme: specialist managers, first-time funds, co-investments and smaller specialised secondaries.

According to PEI’s Research & Analytics division, specialist managers with whom Adveq has a relationship include UK turnaround specialist Endless and UK lower mid-market specialists Synova Capital and Bowmark Capital.

“We do have a history of backing first-time funds,” Creed says. “The most extreme we did was a first-time fund in a group that were a first-time team who were also even first-time investors. That’s quite unusual to be that extreme, normally we try to ensure that we limit at least one of those three things.”

First-time funds are a tempting proposition for investors: in aggregate, they outperform more established groups. However, the range of outcomes is much more binary, with a large number significantly underperforming. Picking the success stories takes a trained eye. “Backing a first-time fund is very, very hard,” says Creed.

The lack of legacy portfolio, strong alignment of interest and clear focus of the individual teams make for a compelling argument for backing such a fund. But they also carry much greater risk; teams generally have not worked together before, do not have a reputation as a group and do not have an established sourcing network. That’s all without the undeniable fact that “investing institutional capital as a mid-level person in one firm is very different from investing institutional capital as a founder or as a senior executive in another firm”.

FIRST-TIME FUNDS

Evaluating first-time funds is much more time-consuming than appraising more established groups.

“You have to meet many of them and you have to meet them over a long period of time, and you’ve got to see their evolution during that time,” Creed says. “We’ve been very successful with some of the ones that when you first look at them on paper you would say, ‘That’s too risky, that doesn’t look like that should deliver.’ But then by spending enough time with them we got comfortable with them for one reason or another, and then they have done very well.”

Backing first-time funds allows Adveq to build strong relationships with managers from the get-go, which can be invaluable in later fundraisings when their vehicles become oversubscribed.

“We support first-time funds a lot more, which has to do with wanting to build this very close relationship with the GP,” Lidén says. “History tells you that you build those relationships if you’re in the first fund, because that’s when they really need help. In the second fund they might need help, in the third fund nobody needs help anymore. It’s only historical relationships that count.”

The firm’s “GP-friendliness”, including having one team that works across its primary, secondary and co-investment deals to simplify communication with managers, is the “one thing that sets us apart from any of our similarly-sized competitors”, Lidén says.

“We try to treat them as clients and not treat them as somebody who’s coming begging for money from us, which I think is more of a mind-set, that you respect their abilities, their qualities.”

As both poacher and gamekeeper Adveq has a front-row seat in the current debate around private equity fees, negotiating both with managers and with their own investors. Far from the headache it has been for other players in the industry, Lidén, Ender and Creed seem remarkably nonchalant on the subject.

“Fee discussion is not core. We want to see how people can create value, what they can bring,” Lidén says. “If you work with smaller funds, especially start-up funds, ‘2-and-20’ doesn’t sound that absurd. If you have $50 million, 2 percent is basically a million a year, which if you have a staff of six or seven people plus an office in London, that’s not gold anymore.”

Creed offers an anecdote from a day in June 2011 when Adveq committed to two GPs in Europe, one the most expensive and one the cheapest the firm has ever backed in the region.

“We spend considerable time looking where that fee is going to go. The most expensive team that we committed to, for example, that was the biggest team for its fund size in Europe, so the main senior individuals were on substantially lower pay than you’d see in comparable size groups,” he says. “We felt comfortable they were using the money in order to make their investment proposition better.”

MANDATES

Adveq’s own fee structure is a “very simple” fixed management fee and performance fee, with rebates for larger investors and those who commit prior to the first close. Carry is distributed across the organisation to those who worked for the firm at the time the particular fund was being invested. This also applies to the majority of individual mandates.

“I think that’s pretty unique in the industry because a lot of people use mandates as an excuse to lower fees,” Lidén says. “We want to treat everybody the same.”

Thanks to its “disciplined” approach to fees, Adveq has avoided much discussion around fees with its investors.

“We actually raised our fees two years ago in a market where everybody says funds of funds fees have gone down, down, down,” Lidén says. “They will probably continue to go down, down, down if we’re talking about primaries only, but with all the added value we offer through co-invest and secondaries nobody was actually walking away because we were increasing our fees. We had nearly 100 percent repeat clients coming back again, and fees were not the issue for the people who left.”

Investing through a group such as Adveq, Creed adds, is “only a very small increase in the total fee load of investing in private equity”. “The big question is whether the access and performance that we can generate exceeds that small increase.”

Adveq, of course, argues that it does.

“If [investors] say, ‘Fees is the most important thing we’re looking at,’ we know we’re going to lose, just full stop, we have no chance. We see ourselves as an alpha provider, we see that we create value to the client, and there’s a price to that value which he has to pay,” Lidén says.

“The fees should actually not play that much into their decision-making because we should create more value than we charge fees, otherwise we have no right to exist.”

Adveq may have managed to prove its investment proposition and shore up its investors, but the future is not without challenges.

“What is probably the biggest risk we are facing is that [LPs] get so big they want to do it themselves,” Lidén says.

“It’s probably something that goes in waves and cycles. We’re currently more in a cycle of people thinking about doing it themselves, trying to do it themselves. But it’s ultimately a difficult strategy.”

TALENTSPOTTING

The first challenge is to find the right talent. Many pension funds simply cannot pay the salaries required to lure the top talent away from the industry heavyweights.

“You need really good people to execute direct deals, especially if you want to be in the lead,” Lidén says, pointing out that there’s an ocean of difference between being an experienced co-investor and taking on the challenge of actually buying and transforming a company.

“Private equity is an industry which we think is difficult to execute. That’s why I think there’s a justification for this industry,” Lidén says. “If anybody could buy a company, make it a lot better and then sell it again, then you wouldn’t need an industry. And the fact that not even all private equity funds are successful shows that actually it’s a very difficult strategy and you need really good people and a good structure to execute it. And I just think many of the institutional investors who are trying to do this on their own don’t have it.”

Another significant challenge is regulatory change which, Lidén admits, is tough to mitigate.

“You can basically diversify your client base, which is what we’ve done, both geographically [and] through different sectors,” he says, adding that the main bulk of Adveq’s investors are pension funds and insurance companies, along with endowments in the US.

“They’re all under different regulations, which means they probably shouldn’t turn negative on all of them at the same time, which is obviously the risk you want to avoid as a CEO of a company like ours.”

With an AUM that has been growing steadily since inception, Adveq shows no signs of slowing. It is currently in market with its debut dedicated European co-investment vehicle and Adveq Europe VI, which will focus solely on specialised small and mid-market buyout firms.

Adveq declined to comment on the status of its sixth European fund, but investor sources indicate interest has been strong, and the fund is expected to close north of €300 million.

Investor sources also indicate that the group is raising a global investment fund, which will close later this year, and its eighth dedicated technology vehicle. Adveq declined to confirm the fundraisings.

With individual mandates opening up opportunities in Africa, Latin America and Russia, Lidén’s dream of becoming a truly global firm is within striking distance.

“We are half way there but not fully,” he says. With a focus on smaller and specialised managers, Lidén accepts that Adveq “will never be one of the largest”, but size, after all, isn’t everything.

“I think ‘alpha provider’ for me is the key word if we define what we’re doing in this business,” Lidén says. “I think of ourselves as a thought-leader in the industry, and I think that’s what we really want to be. We want to be at the cutting edge of the industry, we want to be the ones that people ask what’s going on in the industry.”

So next time you’re passing through Zürich, why not make a point of stopping by the Adveq office on your way to the airport? You’ll likely be treated to a differentiated view on private equity.