Global financial crisis: ‘The phone just stopped ringing’

An LP and a GP reflect on the events of September 2008 and how it changed them as investors.

Richard Clarke-Jervoise was co-leading the private equity fund investing unit at French insurer Groupama when Lehman Brothers collapsed. From his Parisian office, more than 3,500 miles away from Manhattan, the end of Lehman Brothers, while certainly significant, did not feel like an immediate seismic shift. The failure of insurance giant AIG, however, is firmly imprinted on his memory.

“I specifically remember one phone call with a friend working at one of the big banks the morning after they announced that AIG was going to fail,” he tells Private Equity International. “People were genuinely scared that it was going to be a game of dominoes; that the whole system was going to melt down.”

Richard Clarke-Jervoise

Clarke-Jervoise was investing capital for a range of clients. Parent insurer Groupama accounted for around half the money and third-party clients – mostly insurance companies and pension funds – for the other half. Did the collapse of a giant in his sector – albeit on the other side of the Atlantic – make him fear for the near-term health of his own institution or clients? No, he says. “It was really just trying to figure out what was going to happen next and what all of that would mean for private equity, the financial sector and the economy at large.”

The strangest thing, he recalls, is that LPs went from being incredibly busy committing capital (“certainly the busiest time in my career as an LP up to then”) to nothing. “We were fairly overwhelmed with work; there was so much going on all the time it was slightly reminiscent of the current environment, where the hamster wheel just spins and spins and spins,” he says. “Then overnight the phone stopped ringing.

“No one was trying to fundraise at all. In 2009 I think we made two commitments to traditional funds, where we normally would have made five to 10.”

Most people “had the sense” not to try and raise a fund at all, notes Clarke-Jervoise, before qualifying the point. “We took advantage of the crisis to raise a fund – an opportunities vehicle that invested in distressed debt and secondaries – and it was with hindsight one of the best performing funds that we’d managed.” In this case success looked like “between 20 and 25 percent net” he recalls.

With no one raising capital, an LP’s days were taken up with firefighting: limited partner advisory committee meetings to work out how to deal with funds that had failed to raise enough money to reach critical mass – and become stuck, undersized, owning one or two assets; or to deal with one of the key-person issues that arose. “And there were the calls about portfolio companies and the fact that valuations were taking a hammering,” he adds.

Size matters

The key lessons that Clarke-Jervoise, who now leads private equity investment for multi-family office Stonehage Fleming in London, took away from these experiences? One is the importance of fund size.

“It was the GPs who had massively increased their fund size – those were the difficult cases, because they were reluctant to cut the size of their funds to address the problem upfront and were just fighting against the clock. They were desperately trying to prove themselves, and that lasted for about five years. That’s why we are more cautious about fund size increases now than anything else.”

Another is a desire for GPs not to be too cautious in the eye of the storm. “People genuinely feared that the financial system would fall apart. There were those who were slightly more sanguine and said: ‘If it does fall apart, we are all gone anyway, so we might as well look for the opportunity rather than just looking at the risk’.”

In New York City, Béla Szigethy remembers the moment he heard about Lehman Brothers collapsing, but did it strike fear into his heart?

“PE didn’t have much to do with the collapse of Lehman or the start of the recession. In fact, we didn’t really feel very different,” he says. Szigethy was – and still is – running mid-market private equity firm The Riverside Company alongside co-chief executive Stewart Kohl.

Bela Szigethy

The insulating effect of the private equity model – investor capital that cannot take flight and (in most cases) no direct exposure to publicly traded securities – buffered Riverside from the immediate ripples of the financial crisis, says Szigethy. “We were still able to borrow money for our little deals, our portfolio continued to do pretty well in 2008, and there were times when we were looking at each other saying, I guess there is a recession, but we don’t feel it,” he says.

Recession hits

Then, from 2009 to 2013, the recession hit home at the firm’s portfolio companies. “Normally at our end of the market [lower mid-market buyouts] between 20 and 25 percent of the portfolio is encountering challenges at any one time,” says Szigethy. “During that period from 2009-13, 40 percent were encountering problems … at one point as many as half of them.”

Day-to-day work at the Riverside Company involved doubling down on efforts to work with and monitor portfolio companies. One enduring change brought about by the crisis is that Riverside – like many other firms – has adopted a greater operational role in its portfolio companies.

“That was not the case before 2008,” says Szigethy. “There is nothing like a good recession to shake you up and make you realise what you weren’t doing and what you could be doing to maximise the portfolio’s performance. In a way it was a blessing – a difficult blessing and one that caused our returns to go down, but it’s made us a better firm today and the private equity industry is better today as a result too.”

While it is impossible to determine the precise impact on returns, Szigethy estimates annual value increases from 2009 through 2013 were approximately 4 percent lower as a result of the recession.

As well as prompting greater operational involvement, the long-term effect of the crisis was to alter Riverside’s DNA as an investor. It went from hunting for companies that held market-leading positions in a niche to looking for companies demonstrating market-beating growth.

“We went from being happy [pre-crisis] paying 5x for a company that could be growing at 1 percent a year, to being happy paying 10x for a company growing at 20 percent a year,” he explains. “We went from being value investors to growth investors and today we still look at most companies through that prism. It’s changed us for the better and it has changed us permanently.”