It sounds like the ultimate contrarion position. “Private equity will come out of this strongly. Public equities are back where they were ten years ago. By contrast, people have done well out of private equity. This crisis will show that the asset class can resist a significant market dislocation and still produce attractive returns over the long term. “Amid the global financial meltdown, Ivan Vercoutere, partner at Swiss private equity and hedge fund manager LGT Capital Partners (LGT), appears to be in ebullient mood.
In fact, it transpires that the views of Vercoutere and LGT partner and chief executive Roberto Paganoni are nuanced. No-one should assume from the bold words above that Vercoutere is free of concerns about the difficulties private equity will face over the next couple of years. Nonetheless, as he and Paganoni pull up seats at PEI's offices, he confides that he is surprised by the number of senior business executives who appear to have been panicked by recent events. Smiling, he suggests that it's not the right response.
Vercoutere and Paganoni, one senses, are not easily panicked. Nor do they seem in any way complacent. “This crisis is meaningful,” says Vercoutere. “The dotcom bust was very narrow, nothing like this. And even the Worldcom and Enron shocks were fairly contained. This is extremely broad, global, and affects all of us. It goes to the heart of credit, which is used by everyone. And it will have an impact on private equity, because all financial institutions are under strain.”
As they attempt to steer LGT calmly through the turmoil, the two visitors from Pföffikon near Zurich are able to call on a deep well of experience, as well as knowledge of many different markets. Half Dutch and half Italian, Paganoni qualified as a mechanical engineer in Germany before going to business school in Switzerland. He then spent eight years at McKinsey & Co, where he worked across many of the firm's European locations, including Belgium, Spain and Sweden.
Vercoutere, meanwhile, was born and grew up in France before in 1986 heading off to business school in the US “for the summer”. He ended up staying for 12 years, including a spell in the La Jolla, California headquarters of private equity advisory firm Pacific Corporate Group from 1992 to 1997.
It was in December 1997 that the two men met and hatched plans to set up a business managing hedge funds and private equity funds. When they were handed a mandate to invest an endowment on behalf of the princely family of Liechtenstein, reportedly among Europe's richest royals, the business was up and running.
The dotcom bust was very narrow, nothing like this. And even the Worldcom and Enron shocks were fairly contained. This is extremely broad, global, and affects all of us
Since the birth of the firm 11 years ago, it has brought on board between 160 and 170 global institutional clients including pension funds, insurance companies and other endowments. It now manages around $12.5 billion through its private equity investment programmes and $6.5 billion through hedge fund programmes headed by fellow founding partner Thomas Weber. The firm has 150 professionals, the bulk of them in Switzerland, plus around 20 in Hong Kong, 15 in New York and a modest number in London, Dublin and Tokyo.
The firm's strategy is focussed around regional funds of funds investing in the mid-market and small buyout spaces in Europe, the US and Asia. Approximately 20 percent of the available capital is reserved for secondary opportunities as a way of mitigating the J-curve, and the firm also has a dedicated secondaries offering targeting the smaller mid-market.
Because of its focus on the middle and lower ends of the market where leverage is less prevalent than at the larger end, LGT's fund managers and underlying portfolio companies have to date avoided being hamstrung by the credit crunch. Paganoni concedes, however, that problems will arise due to a lack of demand as the credit drought spawns problems for the ‘real economy’.
Despite this, he is optimistic for two reasons. First, he says that LGT has analysed all the fund commitments it made following the bursting of the dotcom bubble from 2001 to 2003 and found that these commitments delivered annual rates of return between 20 to 40 percent per year from 2004 to 2007. The conclusion: downturns can be very profitable. Market conditions that may appear gloomy will nonetheless offer “once-in-a-lifetime opportunities”, Paganoni maintains.
Second, he has faith in private equity firms' much-vaunted operating strengths – and believes that their ability to roll up sleeves and do whatever work is necessary to transform a company's for tunes are absolutely in keeping with the times. He notes that, at the recent meeting of the G20 nations, there was a lot of talk about developing “toolkits”to deal with the financial crisis.
The fact that GPs have many tools at their disposal“ is crucial in a crisis”, says Paganoni. “In public markets, you just buy and sell – that's all you do. Private equity adds management, incentivises people, makes acquisitions, etc. That model is very resilient in tougher times.”
Asked whether LGT will seek to maintain the same pace of investment in the period ahead, Vercoutere stresses that a consistent approach to the asset class is important, by which he means avoiding over-committing to the up-cycle and under-committing to the down-cycle. “Consistency is key,”he stresses.
In public markets, you just buy and sell – that's all you do. Private equity adds management, incentivises people, makes acquisitions, etc. That model is very resilient in tougher times
Taking up the theme, Paganoni adds that LGT does not consider itself a “volume player”and therefore does not feel compelled to shovel money out of the door. A more important consideration is that it does see itself as a principal investor. “We invest a lot of money on behalf of a family endowment and also the whole team here – the partners commit their own capital. So we have that principal investment angle and we make sure that the size of our programmes is always commensurate with the size of the opportunity.”He adds: “Some of our programmes over the next two to three years may be a little smaller depending on the opportunities we see.”Paganoni and Vercoutere don't believe that new deal activity has dried up, or is likely to in the near future. The latter has figures at his fingertips showing that while deal volume for the largest deals had declined by almost three-quarters in the first half of this year, the smaller end of the market was down by just a few percentage points. He proceeds to explain why: “This is core business for the banks. They don't package and syndicate the small deals where borrowing is around 3 to 3.5 times EBITDA. These are businesses that may have been clients of the bank for 20 or 30 years. The bank knows them and it's happy to keep the loans on its books.”
Asked whether banks may even neglect core business given the extraordinary nature of recent developments, Paganoni doesn't give a direct answer but meditates on the suggestion in the following way: “Could things change even there, at least for the short term? Well, the last four to six weeks have been exceptional…”
And when times become exceptional, it arguably becomes possible to lose sight of certain fundamentals regarding private equity performance. The two men from Pföffikon will not fall into that trap. Paganoni pulls a document from a sheaf of papers arranged in front of him and flips to a page illustrating the performance of LGT's private equity portfolio over a ten-year period. It shows that it has outperformed public market benchmarks by between 1,000 to 1,500 basis points during that period, which Paganoni says is way in advance of the 500 basis point out performance that might reasonably be expected over such a time frame.
The point he is making, which is in danger of sounding a little clichéd but is no less important for that, is that private equity is a long-term game. It has the capacity, over the spectrum of a ten-year fund life, to absorb shocks and, at best, to emerge the other side with glowing performance credentials – or at least, sufficiently impressive relative performance to justify its raison d'etre within investors' overall portfolios. He does not see any reason to fear that this ability has somehow diminished today.
One of the prime concerns from a limited partner perspective, and which is given consideration elsewhere in this issue, is the knock-on effect that the shrinkage of capital pools caused by plummeting stock markets has had on the ability to meet private equity commitments. Referring to LGT's own investor base, Paganoni says: “Most of our investors are long-term oriented pension funds and they're not seeing too many problems. They do have more of a requirement for cash flow planning, but they are meeting their capital calls. They've had such good results over the last few years that it would take something really dramatic for them not to meet a call.”
Expanding on the theme, Paganoni acknowledges that the constraints some limited partners are under may have an impact on new commitments for the next couple of years. He also thinks that “some institutions will go beyond their stated percentage commitment limit in order to remain consistent”, while“ some won't be able to do that and others will be more conservative”. On balance, his view is that there will be less money in the pot – but clearly feels any depiction of a mass retreat from the asset class would be wide of the mark.
What's changed is that all of a sudden people are looking at risks they've not looked at before
What Paganoni has noticed is a phenomenon that reaches well beyond LGT's investor base and, indeed, private equity as a whole – and that is a reappraisal of investors' risk exposure. “What's changed is that all of a sudden people are looking at risks they've not looked at before including, for example, which parties money passes through before it is invested: Which party is the money with? What does that party do with the money? Do they retain it on their balance sheet or does it go somewhere else?”
Such questions are being asked because, unsurprisingly perhaps, investors have got the jitters amid extreme market volatility. This volatility has enabled politicians to take centre stage with their interventions and bail-outs – as markets have been forced into rapid retreat, so too have proponents of laissez faire capitalism. The markets did not turn out to be effective at regulating themselves, so many will now argue.
Says Vercoutere: “For 25 years we have lived in an economic environment that has been quite stable, while also being what you might call a political bear market. We had steady growth – albeit with a few bumps along the way – a steady reduction in the cost of capital, and equity appreciation. As [former Federal Reserve chairman] Alan Greenspan said, that 25-year trend has been broken. Now it's a political bull market, government intervention is greater than at any time over those 25 years. Deregulation has come to an end.”
And, as deregulation takes its place in history, it's natural for all those operating in the financial services sector – private equity firms included – to assume that new and more invasive forms of regulation are currently being enthusiastically devised by policy wonks the world over. In light of this, admiration of LGT's prescience seems in order. Since inception, the firm has structured the bulk of its private equity products as Irish PLCs rather than limited partnerships because, in the words of Paganoni, they have “a higher level of governance” [the firm also structures SICAFs to cater for the particular regulatory requirements of German institutional investors].
Paganoni says the Irish PLC structure means that investors in its funds are shareholders and enjoy all the rights that shareholders are entitled to under corporate law. “It's regulated by the Irish Financial Regulator and works like an LP structure,”he says. “We issues shares on draw down and when we realise investments we pay the shareholders back by redeeming the shares. It works the same as an LP, you get your liquidity after the investment period, but for the period of commitment you are a shareholder, with many more shareholder rights incorporated, than would be the case in a classical LP structure.”
Adds Vercoutere: “We thought it would be beneficial to be held to a high standard of transparency and corporate governance because public pensions require that and get great comfort from it. There are no side letters in our funds, which means that no-one is treated differently – all our shareholders are treated the same. Given what's happened in the markets, we look on this as a strong positive.”
Contrary to those who might see investment firms and regulators as being factions permanently at war with each other, Vercoutere admits to an affection for Ireland's financial police: “The Irish Financial Services Regulatory Authority has always proved accessible and has turned documents round quickly. I'd even go so far as to say that, for an oversight body, they're fairly entrepreneurial.”
There are no side letters in our funds, which means that no-one is treated differently – all our shareholders are treated the same. Given what's happened in the markets, we look on this as a strong positive
What about the future for LGT, I ask. What are the firm's priorities over the coming years? Like many funds of funds businesses, LGT is now on the ground in Asia, having appointed former IFC executive Doug Coulter to lead its Asia Pacific investment activities from Hong Kong in March 2007. It is clear the two men in front of me have high hopes for the region. “Asia's emergence will not recede,”says Vercoutere. “As long as Asian markets keep growing their private equity infrastructure and good managers keep coming through the pipeline, investor diversification into that part of the world will continue – the signs are that is continuing through the crisis.”
LGT CAPITAL PARTNERS AT A GLANCE
|Offices: Pföffikon, London, Dublin, New York, Hong Kong, Tokyo|
|Private equity assets under management: $12.5bn in 350 funds|
|Investment programmes: Crown (co-mingled funds covering strategies including European, US and Asian buyout and venture capital, special situations and secondaries); Castle Private Equity (investment company listed on Switzerland's SWX exchange); tailor-made special purpose vehicles|
|Partners and principals: Jonas Agesand; André Aubert; Franziska Blindow;|
|Maximilian Brönner; Sascha Graf; Sascha Gruber; Andrew Kwee; Dimitri Kroujiline; Hans Markvoort; Cem Meric; Stefan Mühlemann; Wolfgang Müller; Roberto Paganoni; Robert Schlachter; Tycho Sneyers; Ivan Vercoutere; Werner von Baum; Thomas Weber|