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Investor profile: Jonny Maxwell, chief executive, private equity, Standard Life Investments

Maxwell on why he thinks that some firms are fleecing their investors, on cowboy fund of funds managers and on what he's most excited about in private equity.

Standard Life Investments currently manages two private equity funds of funds: a partnership, the E868m European Strategic Partners, and a listed vehicle, launched on 29 May this year, Standard Life Private Equity Trust. The funds have invested in some of the brightest private equity names, such as Apax, Candover, CVC, Index Ventures, Alchemy and Mercapital. Jonny Maxwell has nearly 17 years of private equity experience behind him in both direct and fund investing.

What's the current state of play with your private equity funds?
'European Strategic Partners invests 60 per cent in funds and up to 40 per cent into direct deals as co-investments. It's a pan-European fund, with the main focus on mid-sized buy-out funds, but we're also taking a limited exposure to venture funds and large buy-outs.

'We're on target. ESP currently has 20 funds and nine directs and we expect to complete two more funds in the next two weeks. After that, we'll just be doing co-investments.

'We also have Standard Life European Private Equity Trust  - or SLEPET as it's known. That came about while we were marketing ESP. A number of people we went to see said they couldn't take exposure into a limited partnership directly, but could take exposure to private equity through a listed vehicle. We had what you might call the old Standard Life portfolio, with the track record and expertise. That has generated significant returns over the course. To May this year, we were at 44 per cent compound since 1993 and 26 per cent since 1982. We think that is a very strong track record over a long period of time. We transferred 19 funds into the trust and took 50 per cent of the shares rather than cash off the table. Then we matched with cash funding from outside investors. We think that the management fee on that is probably one of the best in the market. It's at 0.8 per cent on net assets. The new cash raised doesn't pay a fee for a year, so the cash drag is minimised.

'That trust is going to plan. We've invested in five new funds, so that takes us to 24 funds. We also have cash in place to continue making commitments. The end focus is on Europe and it's funds only.'

Direct investments are notoriously difficult to do and some might say that a fund of funds isn't necessarily equipped to make the right decisions. How would you answer that?
'I think we're different from most other funds of funds in many ways. One of these is because we have significant direct investing experience as well as fund experience. This helps us on both sides because when we're looking at managers we can take a cynical approach to their strategy and whether they can deliver and whether what they say they're doing actually works.

'We also spend a lot of time an effort making the right decisions. Out of a team of seven of us, we spend two man years out of the office in 365 days. We have to use all the technology we can to ensure that we work cohesively as a team. You can't do this from your office. It's a naïve investor who thinks you can.

'We're aware of investors who have said that they were very interested in direct co-investments but who can't react in the timescales required by the managers, who can't get their travel budgets approved, or who don't have the due diligence capacity to take a decision on direct investments. We've seen quite a lot of investors, particularly in the US, who would like to do co-investments in Europe but would actually find it very difficult. Say a guy in mid-west America gets a call saying, "We've got a deal, the paperwork's all in Dusseldorf, and you have to do your diligence, and commit 21 days from now". You'd find that with a lot of the larger investors - state funds perhaps - that their infrastructure doesn't allow them to get the approvals that they need to jump on a plane, spend two weeks in the company going through the books and then go back and get the authorisation. They may have the capacity to co-invest, but their delivery on the ground is sometimes difficult because of the obstacles that their organisations put in place to control procedures.

'We don't have those constraints because Standard Life doesn't participate in those decisions. We can respond very quickly. I can think of deals where our guys have hung up the phone and gone straight to the airport. We've done it before. We know about it. It's what we do as well as buying funds.'

Do you think that there's also a lack of knowledge and experience in some of those institutions wanting to co-invest?
'In some, clearly there is. The more worrying thing for me were I a trustee would be that there may be some knowledge and experience in particular sectors, but not necessarily in the arenas that are being pursued. A US investor, for example, who has a lot of experience of doing deals in the US doesn't by definition have the ability to transfer that knowledge to a Scandinavian or Spanish deal or wherever else. The reverse is equally true. If there's a European investor that wants to co-invest and sees US opportunities, it doesn't follow that because you've done it in, say, Germany that you can do it in the US.'

What advice would you give to investors new to private equity?
'The best piece of advice is: know what you don't know. I don't want to be glib about it. But it's far better to pay someone a marginal fee to get the decision right than to take an entire write-off. It's much better to pay a manager £100,000 a year to manage £20m or £10m of assets, whatever the fee structure may be, than to make a £10m investment and write off that £10m.

Although some would argue that the fees aren't marginal when compared with other asset classes…
'If you have the right manager then the return should be commensurately higher. We've got 44 per cent compound against a return in the mid-teens on the MSCI index over the same period of time. Yes, you may pay higher fees, but you get double the returns. What's in the client's interest?

'The fact is that it takes a lot more time and effort going into a private equity deal, managing it and exiting it than it does a quoted share. With a quoted share, you get your research in, you pick up the phone and you buy or sell the stock and that's the end of the trade. With private equity, you can spend three or four months in due diligence and incur millions of pounds' worth of costs making sure that the deal is right. After that, you're attending weekly, bi-weekly, monthly meetings for a number of years and then you've got to secure the sale. The comparisons are rather naïve.

'However, I think that the industry is guilty of ignoring the economies of scale that underpin the logic of fund management and, ironically, underpin the logic of a lot of the underlying companies that they buy. You find a manager that raises £100m one year, £500m the next and £1bn the next. He adds two people to his team and then still seeks to justify a two per cent management fee.

'We went to see one investor who had gone into a fund and he said that he was very impressed by the amount that the general partner was contributing. We pointed out that the step-up in the size of the fund represented the surplus profits of three years' management fee income from the last fund. All he was doing was recycling his management fee as a contribution. If you raise a fund that's ten times bigger than your last one, you have to wonder whether the overheads have gone up ten times. Where's the incentive? Is it derived through the profits of the management company and to hell with the returns? Or is the manager still focused on making capital gains? There is a point at which managers start thinking, if we're making £10m a year management fee for ten years, the carried interest becomes less of a motivator.'

There seem to be an increasing number of funds of funds being set up at the moment. How does this affect players like you?
'I'm quietly confident. I would happily put our track record against the best of the market over the longer term. I think some of the technology funds of funds will have some interesting reports to read at the end of this financial year.

'It's natural that there will be more players in the market as people start recognising what they don't know. The danger is that there are an awful lot of "me-too" managers setting up. I've been concerned for years that, as the asset class becomes more popular, people with distribution will raise money because they can - not because it's an appropriate strategy or because they can appropriately deploy it. Some of the investment bank-type mentality tends to prevail: technology was in favour for two years, so everybody raised technology funds. Now technology is like a swear word. Nobody wants to talk to technology funds anywhere. There was a lot of money raised by "me-too" fund managers who said, "I can make you a fortune". Those who sold out in time probably did make a fortune, but those who held on will have lost a lot.

'My concern is that people with very little experience go out and raise funds from investors who don't know that alternatives are available. Having distribution doesn't equate to having the requisite experience.

'We've seen people out there raising funds who have borrowed significant parts of their track record from the institution. It absolutely amazes me that people are able to raise money with track records that are either so short as to be meaningless or in the presentation of them there's some lack of integrity. Clearly a lot of people in this business are professional and adhere to standards of integrity. But I think that as we start seeing more and more people enter the market, we'll see integrity and presentation by some people being somewhat finessed.' 

What specifically do you look for in a private equity fund manager?
'There are two types of people in the fund management business in the main. One is the person who does it because it pays the rent. It's a job that they enjoy. Then there's the other type who is passionate about it. This type gets off on the deals, the nature of them, the personal interaction, the corporate overview. It may be for testosterone reasons, it may be that he enjoys the cut and thrust or the whole negotiation participation. They don't do this for the money. Money is a nice end part of it all, but they don't necessarily have to work. They have more than enough money in real terms. But they get a buzz out of doing the deals. They are the guys you want more than anyone else.
 
'I also look further than the senior partners. Succession is big issue now. It wasn't such a problem ten years ago. Some of the respected houses of five years ago are now shadows of their former selves, partly because they have lost sight of what they were good at. They've taken money whether they needed it or not and they've started to believe their own press.

'In our due diligence, we go through funds' procedures, their processes, their systems, we talk to deals they've done, we talk to managers they've backed, we talk to managers they haven't backed. We do an immense amount of due diligence. I know everybody says that. I've been involved in direct deals where co-investors have never shown up to the company's office once and I find that extraordinary. You'd be amazed at some of the names.'

What's the biggest mistake you've ever made in private equity?
'It was very early on in my career and I'd just joined a private equity firm. We were making investments in what was considered then to be a technology firm. We were paying them in tranches. I had to go to the business and deliver a cheque. I just smelt something really fishy about this company. So I rang my boss. He started tearing strips off me and told me to leave the cheque. So I did.

'Then the next payment date came and I had to deliver another cheque. It was £250,000, so not an inconsiderable amount, especially at the time. When I got to the business, it smelt even more fishy than before. I called my boss and he told me to talk to him later. But I couldn't wait. It was Friday afternoon. So I made the decision not to leave the cheque. The managing director was threatening me and saying that I would be responsible for the business going down. Anyway, we called in an investigative accountant. He found £50,000 worth of uncashed cheques stuffed in the back of a filing cabinet. It then transcribed that all the sales receipts we'd seen had be very elaborate photocopies. The company eventually went bust. So my biggest mistake was leaving the first cheque, one of my best decisions was not leaving the second.'

Which areas are you most excited about, going forward?
'The best thing about the current economic situation is that it's a great time to be in cash. We still have 75 per cent of our cash still to draw down and I'm delighted. Multiples are coming back, there are some very good businesses coming out from big organisations, non-core businesses that they're looking to divest. There are still succession issues in certain jurisdictions. The themes that we were keen to raise our fund on the back of have been accelerated or deepened. These were corporate rationalisation, focus on shareholder value, increasing entrepreneurial spirit and European harmonisation bringing all of the barriers to cross-border activity down.

'We're likely to see a lot more great deals over the next few months. We've found that there's normally a lag between a big correction on the listed markets and a correction on the mindsets of vendors as to the valuations of their company. If you're told on 1 January that your business is worth £150m and the market comes back 50 per cent, it's very difficult to adjust your mindset to an unlisted company being worth £75m. For buyers, it's a great time.

'I'm also pleased that we didn't rush headlong into technology. So many people were so excited about it and for a while, I thought we'd lost the plot. I thought that maybe the world was smarter than we were. But we took the view that if we were wrong as an organisation in our approach, then we'd probably be out of business. If we're right, then we'd be able to continue to generate the returns that we have in the past. There were a lot of great ideas that got funded; there were a lot of terrible ideas that got funding. It's just a shame that the great ideas are now suffering.'