When Mark Redman looks to hire a new team member, he’s seeking much more than just a good track record of investment.
“It’s also about people who have their feet on the ground, people who have a degree of common sense, a degree of humility,” he says, before adding with a wry smile, “which is not always something you see in private equity.”
As executive vice-president and global head of private equity at the Ontario Municipal Employees Retirement System, a C$72 billion ($54 billion; €50 billion) Canadian pension fund, Redman is perhaps more concerned than your average rainmaker with making sure the thread between the deal makers and the fund’s ultimate beneficiaries remains intact.
“The culture is incredibly important, understanding ultimately why we’re here and what we’re doing it for,” says Redman, who was promoted in August from head of European private equity to oversee the private equity programme globally. “Ultimately, there’s a clear line of sight between what we do in terms of investing and who we actually work for.”
Redman himself has direct contact with OMERS members, meeting pensioners, pensioners’ representatives and union representatives every few months.
“Quite often what we do in the City and the financial services sector, there’s inherently a disconnect between the people whose money you’re investing – insurance funds, pension funds, whoever it might be – and what you’re actually doing. Here there’s direct connectivity,” he says.
“Recruiting people who have got fabulous track records of investments and returns, but also who get that? It’s surprisingly difficult.”
Recruitment is something OMERS Private Equity has been doing a fair bit of in recent years as it has continued to make the transition away from a predominantly funds-based programme to a programme heavily weighted toward direct investing.
“We have recruited a significant number of people like me who have direct GP experience over many years,” he says. “You’re trying to build the experience base within the business while maintaining many of the cultural elements of the business as was before.”
Despite the fact that, as Redman readily admits, OMERS deal makers could easily command a higher salary at another firm, in the London office the fund has a 100 percent rate of retention of investment professionals.
“It’s a range of things,” Redman says. “It’s culture, it’s vision, it’s where the business is going, it’s opportunity. Obviously compensation gets in there as well, and we need to compensate people appropriately such that we can retain them.”
OMERS looks to “essentially replicate a GP compensation package”, which means the team is fully incentivised to generate the highest returns possible.
“The private equity model is incredibly powerful in that way, that you basically don’t make money if you don’t make the returns,” Redman says. “That was something I was very keen to get in place certainly when I came into the business, and I’m confident that we have a scheme in place that is fully aligned in that way.”
After 13 years at 3i Redman joined OMERS in 2009 to set up the London office. At that point the fund was already in the midst of the transition toward a programme dominated by direct investment.
“We were essentially two-thirds funds and roughly one-third direct investments,” he says. “Today that is more than reversed, we’re at north of 70 percent directs.”
The aim, says Redman, who describes OMERS as “in the vanguard of direct investing for Canadian pension funds”, is to “retain a handful of strategic fund investments” and to move to “north of 90 percent” invested directly in the next five years.
OMERS currently invests directly in North America and Europe. The strategic fund investments are likely to focus on Southeast Asia, where the fund currently has indirect exposure through both its funds programme and through direct investments that have operations in the region. Latin America is another potential region the fund will look to explore further through fund commitments.
Although not immediately on the cards, Redman foresees a time when OMERS will be investing directly in emerging markets.
“I’ve learned over the years you don’t want to run before you can walk,” Redman says. “But a logical first step would be to build on the limited but existing emerging market presence that we have in our funds programme, use that funds programme strategically – which is effectively what we would be doing – and then, over time, who knows?”
The attraction of direct investing is clear: in a funds programme “you’re haemorrhaging a reasonably high degree of fees”, Redman says. Returns in the direct investment programme, thus far at least, “have been exceptional and well in advance of our funds portfolio”.
But running before it can walk would perhaps be the criticism levelled at OMERS by its peers who have chosen to stick with large funds programmes, both in Canada and across the LP universe. The upside of direct investing is certainly enticing, but the model is not without considerable risk.
What would Redman say to those who question whether OMERS is moving too fast?
“First and foremost I’d point to returns,” he says. “I look at the money we would ‘lose’, in inverted commas, in fees and in carry to a funds programme, and I look at the returns that we generate in our direct programme, and I’m very comfortable with the model that we have.”
The way Redman sees it, as a fund such as OMERS grows its direct investment programme, the risks actually diminish.
“In the early days, when you made a direct investment it could be a significant part of your portfolio,” he says. “Today it’s north of 20 direct investments that we have, so we are as diversified as any typical fund would be.”
He adds: “It would mean that typically an investment wouldn’t be much more than 5 percent of the fund, therefore if you did drop one, whilst it’s not great, it wouldn’t crater the whole business.”
Investing in a diversified portfolio of assets is no more or less risky than investing in a diversified portfolio of funds, Redman posits.
“You shouldn’t imagine that because you have a funds portfolio they will all perform brilliantly, you’ve got to select the right funds, just like investments,” he says. “You might have an investment in 25 funds, you might have an investment in 25 investments. Is there a difference? I’m not academic enough to know, but I suspect statistically there’s not that much difference between those two models.”
However, Redman is quick to clarify that others’ investment strategies are equally valid, and indeed in some areas, such as international expansion and geographical diversification, OMERS is trailing some of its peers.
“It depends which metric you use,” he says. “I don’t want to prejudge their investment strategy, I’m not saying they’re wrong. It’s just slightly different than us.”
A CAUTIOUS APPROACH
Due to the increased and increasing amount of time, energy and resources dedicated to direct investing, the day-to-day operations at OMERS PE are effectively those of a GP.
“The feel and touch of it is very much like a GP, but a GP with permanent capital, with patient capital,” Redman says, adding that this makes “quite a difference” when it comes to attracting management teams to work with the fund.
Redman describes OMERS PE as an “involved investor” looking to partner with management teams. The fund has a focused approach to investing, identifying micro-niches within the business services, industrials, healthcare and software sectors and investing between $100 million and $500 million in each transaction. In Europe, OMERS typically has a shadow portfolio of 10 companies, three or four of which it will bid on, and one or two it will eventually acquire.
Seeking top decile and top quartile businesses, OMERS runs up against “the top blue-blooded firms” such as Charterhouse Capital Partners and Cinven. Unencumbered by the constraints of a fund model, OMERS is in no race to invest its capital and, although it sticks to an average hold period of five years, it’s in no hurry to take its money back again, a tempting prospect to management teams looking for a partnership approach.
“We’re still a cash-to-cash investor, the discipline of cash-to-cash investing is a good thing, but it does mean we’re able to be flexible in terms of the way that we operate with the company.”
The fund’s focused approach to deal sourcing also reassures vendors and management teams that it will follow through on an acquisition.
“When we decide to do something, unless something extraordinary comes out of diligence, we normally do it,” Redman says. “I think that’s the reputation, for deliverability, credibility, trust, for want of a better term, that I think we’ve been able to develop in a relatively short period.”
That credibility and trustworthiness is part of the OMERS culture to which Redman repeatedly refers.
“Just by maintaining that culture and that approach, I would argue, that, in many way, differentiates us substantially from the market,” he says. “The proof has been in our ability to win the deals that we’ve won over the years.”
Deals in Europe this year include the $1.7 billion acquisition of Environmental Resources Management from Charterhouse. OMERS partnered on the deal with The Alberta Investment Management (AIMCo), with whom it had also acquired the UK’s Vue Cinemas in 2013 for £935 million.
As a fellow Canadian pension fund, OMERS has a “natural affinity” with AIMCo, although OMERS will “happily work with other institutions”. When choosing a co-investment partner, once again culture is the deal-breaker. “There’s got to be a good fit not only in terms of aspiration for the business, longevity of view, patient capital, but also culture,” he says.
OMERS has a slightly less aggressive approach than the rest of the market, Redman says, and tends to use less leverage, issues regarding which any co-investor needs to be on the same page.
“You might imagine that there’s loads of people, but finding the right people to partner with is not as straightforward as you might imagine,” Redman says. “There’s a wall of money out there, there’s plenty of money, there’s plenty of firms. Finding the firms that are a good fit – AIMCo is – is actually surprisingly difficult.”
Although willing to partner on deals, Redman says the fund tends to steer clear of minority investments and situations in which it is one of a number of investors.
“Maybe it’s our healthy paranoia, as I call it. We’re very focused on being able to appropriately influence the businesses in which we invest,” Redman says. “We try to avoid complexity. Complexity is the enemy of good returns in my experience.”
OTHER PEOPLE’S MONEY
As the guardian of pensioners’ money, corporate and social responsibility infuses every decision OMERS PE makes.
“I will get asked by people why we invest in certain businesses, and you’ve got to be able to stand up in an investor meeting or in a pensioner meeting and explain why you’ve done what you’ve done,” Redman says.
“That’s again my point about the direct connectivity between ultimately who owns the business or owns the fund – which are the people who put money into it – and ourselves. CSR means more because you’re dealing with individuals who are actually concerned about it, rather than being something that’s imposed by a regulatory body or by some faceless institution. These are real people who are really concerned about those things, and actually think about it and worry about it.”
Investing on behalf of a pension fund has clear advantages: Redman effectively has one LP – OMERS – to look after, and the lack of fundraising means he can focus solely on making the best investments on behalf of OMERS members. However, Redman concedes that it would be very easy to become comfortable.
“You’ve got the money anyway, you don’t have to go out and fundraise, is there the market discipline? That comes from culture, that comes from the top, that comes from being demanding,” Redman says.
“If you look at what we’ve achieved in the last six years, I don’t think anybody could accuse us of taking it easy or being comfortable. But you have to work hard at that.”
OMERS’s allocation to private equity is around 12 percent, although Redman insists this is more of a guide than a firm threshold, as demonstrated by the two substantial deals the fund has executed this year.
The pool from which to invest is also growing by the day. OMERS is a net inflow fund, with contributions from members exceeding payments. However, that has amounted to just one-third of the growth OMERS as a whole has experienced over the last 20 years; two-thirds has come from investment returns.
“OMERS is growing fundamentally,” Redman says. “We are the complete opposite of capital constrained.”
If the private equity programme continues to pull in the returns it has in recent years – the programme’s net rate of return for 2014 was 14.4 percent, higher than the 12.7 percent generated by OMERS’ Borealis Infrastructure group and the 8.7 percent generated by its Oxford Properties group – then Redman can see a scenario whereby the private equity allocation would be increased.
What that ultimately rests on is Redman’s two resounding preoccupations: returns and culture.
“The whole thing is based on returns. Returns and culture. If you get the culture right, actually, weirdly, the returns will follow,” he says. “Those are the two things I worry about, and I worry about them all the time.”
BY THE NUMBERS
Assets under management
Private assets (as at 31 December 2014)
Capital markets (as at 31 December 2014)
Private equity allocation
Private equity exposure (as at 31 December 2014)
Employees in the private equity team globally.