Hamish Mair is a leading protagonist in the lively private equity funds of funds scene in Edinburgh. Formerly head of the funds of funds unit at Martin Currie Investment Management, he and a team of three moved across town in June 2005 when the business was acquired by F&C.
In the interview below, Mair talks to PEO about his firm’s embrace of the mid-market, its avoidance of large LBO groups and the occasional need to take action against under-performing GP groups.
Where do you see the best opportunities in private equity at present?
HM: We think the best opportunities are to be found in the mid-market across all geographies, and in funds investing in companies with an enterprise value between €50 million and €500 million. That segment is where you can still buy good quality private companies without having to pay very high prices – and it’s where we feel the best returns can be achieved. In some parts of the mid-market it’s relatively competitive but the key indicator in this respect is the price at which deals are struck. We can see deals being done at reasonable multiples, typically mid-single digit enterprise value.
When you have stable but expanding economies and reasonable but not reckless gearing, you should make acceptable private equity returns in the upper 20s to low 30s IRR. Evidence from our funds is that whilst there are pockets of high competition, there are still good deals.
And what’s your view of the larger deal market?
HM: We don’t back any LBO funds for a number of reasons. Most importantly, we have concluded that returns going forward will not be as good as in the past and that their strong historical record cannot be expected to continue. As an LBO firm, you have to invest in large, heavily intermediated and sophisticated auction processes where prices are high and target returns lower than they were. Clearly there is value in well-established private equity franchises, but you must make sure the firm is at the right stage of that franchise.
Do you think management fees charged by larger groups are too high?
HM: Do the maths. These groups can make extremely large profits even if they don’t invest well. If I were an LP in such a group I would want to know the management team was strongly incentivised to make gains. Private equity has become quite different to investment management generally where large portfolio managers don’t expect to charge the same fees as their smaller counterparts. There is a rigid market rate at the moment – but I wouldn’t have thought it’s sustainable in the long run.
What lessons could GPs on the fundraising trail usefully absorb?
HM: There needs to be more evidence of the strategy of the existing fund working – and particularly evidence of exits. Some haven’t achieved any, as a result of which you have to do more due diligence. It makes things more difficult, but you might still back them. Fundraising cycles tend to be dictated by what’s good for GPs rather than LPs. They raise money too quickly before the first fund has proven its worth and achieved significant distributions.
Another issue is effective articulation of strategy. If your strategy is opportunist that’s fine as long as that’s what you say. There is often a disconnect between stated and implemented strategy, which can be a turn-off. It can be convenient to ditch everything from the track record that doesn’t represent the new strategy. Deals based on the former strategy might be quite poor and if only the good investments get included, the GP looks brilliant. That often requires investigation.
How can LPs be proactive given limited liability restrictions?
HM: Limited liability restrictions tend to be slightly overstated. You can’t get involved in management decisions but you can assert your rights as an LP. Certain individuals don’t want us to do that but you can nonetheless. We’ve had situations where managers have cited limited liability to prevent action being taken by unhappy shareholders and it doesn’t hold water. When an outcome has been poor over a long period you have to protect your clients’ money. There are rights in the LPA which as a fund manager you would be reckless in not exercising. In the UK a lot of investors know each other and have similar objectives which means that getting concensus for action is not too difficult.
If we wanted to replace a manager we would try to do it informally but sometimes it requires a formal approach. The GP might want to continue running the fund because it could be the end of his career if he is removed against his will. The natural route if a fund’s fortunes are not retrievable is to merge with another fund or sell the remaining investments. There are honourable options but it doesn’t always happen that way and GPs can get defensive. LPs have investments in 20-30 funds and there is an imbalance in time and energy they can expend versus the GP. It’s difficult to make a difference and not everyone wants to get together – many would prefer a quieter, non-confrontational life.
How do you find the quality of information flow from private equity groups?
HM: It has improved but there’s a big difference between best and worst practice. If you make an effort to establish a relationship, GPs will normally be pretty open but if you’re asking for unreasonable things too often then you will get pushed back. Quality of information is an argument against the big funds – they have hundreds of investors and the chance of getting decent information flow beyond bog standard is quite low. Personally, if I commit capital for ten years I want to know what’s going on.