PRINT THIS PAGE Institutional Investor Profile: Fabio Quaradeghini, Senior Fund Manager, and Jon-Ingvi Arnason, Head of Alternatives, Landsbanki17/10/2007. Source: AltAssets. 
Fabio Quaradeghini and Jon-Ingvi Arnason on Landsbanki’s focus on buy-out funds, on the market for distressed funds, on future investment opportunities and returns in the mid-market, and on why even as a generally cautious investor Landsbanki is looking at opportunities in new markets and segments.
Can you provide background on Landsbanki?
'Founded in 1882, Landsbanki Íslands, formerly known as the Central Bank of Iceland, is the leader in all core banking areas in its domestic market and provides retail banking, corporate banking, investment banking, asset management and private banking services. The bank and its subsidiaries have offices in all major financial centres in Europe, as well as North American offices in New York, Halifax and Winnipeg and an Asian office in Hong Kong.
In the private equity space, Landsbanki has raised two European buy-out focused funds of funds to date. The first fund, Landsbanki Private Equity I, was designed for domestic investors and raised ISK4bn. The latest, Landsbanki Private Equity II, is due to close in the first quarter of next year at or near its cap of €150m after a first close of €80m in June, and is designed to be attractive to international investors while continuing with largely the same strategy as LPE I.
LPE I is currently generating a net IRR to investors of 26.4 per cent with a 1.45 multiple, deploying 55 per cent of capital. For a 2005 vintage fund of funds that performance is exceptional. LPE II aims to continue that outperformance.'
What type of investments do you look for?
‘We focus on European buy-out funds, mainly mid-market and lower mid-market funds, and look at both pan-European single country or regional funds. We avoid the "mega funds", although we have invested with Lion Capital and Carlyle Europe who might be described in that way, but their sweet spot is still broadly mid-market with some notable exceptions. Target funds should be from €100m upwards but ideally no more than €400m in size where their focus is concentrated in a single country or region. Pan European funds can be larger.
Our target allocation is 80 per cent buy-out, ten per cent venture and ten per cent other, probably mainly distressed. Our buy-out investments are sub-divided into 80 per cent small to mid cap market and 20 per cent larger buy-outs (pan European).
We are a cautious investor because our clients are. Iceland is relatively new to the asset class and we do not want to reinvent the wheel. We stick with experienced managers in the more mature private equity markets for the bulk of our investments while at the same time trying to identify managers who are not yet household names despite their good performance. Having said that, we have been quite innovative in how we do things like mitigate the J-Curve through warehousing and use of bank capital, timing of entry and secondaries. This helps to explain the rapid conquest of J-Curve in LPE I.’
You used to invest in buy-out funds only – why did you add a venture allocation in your new fund?
‘We have included venture this time partly because venture investments are less debt financed and that technology in general is a little bit more immune to this credit issue. Also, we think that there is evidence of an inflection point in venture, especially in healthcare and life sciences. It has been a real effort to find funds operating in the venture space that meet our minimum return criteria. So far, we are very happy with our venture portfolio.
Our allocation to funds focused on distressed situations is also new. We think there is enough evidence to suggest that at an inflection point in default rates has occurred, for example, and that the average IRR of a distressed fund with a vintage year co-incident with that inflection point has been exceptional historically, in the order of 50 per cent. We believe that the inflection point has happened and that default rates are going to go well over one per cent, if they have not already.’
What size of investments do you make?
‘Our investment range is €5-15m and we typically invest €10m per fund.’
How many investments do you intend to make over the next year?
‘It will be between ten and 15.’
Do you invest directly?
‘Yes, we usually source our direct investments through our network of placement agents, existing fund relationships and other contacts but this always takes the form of a co-investment.’
How do you conduct your due diligence?
‘We have done some studies on the impact of track record on future performance and we have found that unlike in listed market funds, it is a great indicator of future performance. For example, a fund with a top quartile performance is likely to see its successor fund also in the top quartile, with about twice the probability one would expect in a normal distribution. Lower quartile funds can expect to remain lower quartile in successor funds, if they manage to raise any funds at all. Performance thus has to be top quartile and this, coupled with a minimal return requirement, sets a high bar for us to consider a fund.
Our focus on past performance makes it hard for first-time teams to convince us to commit to their funds. Our strategy, therefore, is not to invest in first-time funds raised by first-time teams. However, if more than half the team have previously worked together in a similar structure and strategy to the one they are in now and have been successful, we would consider a commitment.
Statistics show that after fund three or four teams tend to lose their "hunger" and there are sound reasons why that might happen. Some managers manage to overcome this via an “institutionalisation” process (such as Carlyle) but we do find that certainly funds two or three are the optimal ones to invest in out of a series.
We use an assortment of databases for our due diligence, to provide us with background information, and we rely heavily on our network for reference checks. Gut feel (for lack of a better term) also plays a role in the fund selection process because this is not science, unfortunately, and to make an apples for apples comparison is very difficult. At some point you might have to ask yourself questions such as "Would this ex-investment banking fund manager bond well with an entrepreneur in his twilight years who is generally suspicious of outsiders, and M&A bankers especially? Would the industrialist sell well to such people?" There are no spreadsheets or formulas to give you that answer. Assessing a network and deal sourcing ability is another critical input that is not so simple to quantify. Ultimately, one hopes all these factors combine to generate a good track record and so that remains the main quantifiable criteria.'
What do you look for in a good equity manager?
‘Cohesion is number one: a team has to have worked together as a team for a number of years, for least for one investment cycle. We want to know how they have managed the good and the bad times, how they sourced deals and managed portfolio companies as a team. It all comes back to the importance of an excellent track record.’
How do you put together a new portfolio?
‘There are criteria in terms of diversification by geography, by market capitalisation, by industry, and, to a lesser extent, by investment stage. There is also diversification by manager groups, and we aim at avoiding funds that tend to do many club deals.’
What are the most interesting countries/sectors going forward?
‘In our opinion, Asia is the land of opportunity. Our approach there, however, is to be very careful and not necessarily do what everyone else is doing. Too many people are focused on large buy-outs in places like China and are finding themselves unable to deploy capital. We also look at PIPEs, convertibles and pre-IPO investments because being opportunistic better fits the region. We consider investments in Vietnam, Malaysia and Indonesia because to be truly “in Asia” we should be able to participate in the developing as well as the developed countries. As a result we are teaming up with a local star firm to launch a direct pan Asian private equity fund later this year, the LTC Asia Opportunities Fund. So far it has been very well received with a large institutional mandate for $200m already in place which takes us half way to our target.
In Europe, we believe there are very interesting opportunities in the smaller mid-market, especially among family-owned businesses in countries such as France, Spain, Germany and Italy. We may also do more investments in the South East of Europe, in countries including Bulgaria, Romania and Greece. The overhang is smaller in Europe, the process of becoming an “equity culture” still has more to go and the base of private, reasonably sized family companies ripe for buyouts is much larger than the US.’
What advice would you give to a new private equity investor?
‘I would tell them to think very, very hard about J-Curves, and to factor that in very, very carefully when they produce their return projections.
Also, it is our fundamental belief that the days of the mega fund and leverage being the key to performance are over. In this environment, you want to stay away from funds that are purely using financial engineering and leverage to generate returns, and you want to focus on people who are genuinely adding value to the businesses, people who are operationally minded. The discipline of debt is great, but to paraphrase a comment by Warren Buffet when talking about leverage: any data series that ends with a multiplier of zero gives you zero.'
What are the main issues the private equity industry needs to address?
‘I think we need a discussion about fee structures. If you are paying two per cent of commitments as management fees, and your private equity fund managers do not deploy your capital very quickly, then you really suffer from the J-Curve effect. That is something that needs to be addressed. On the other hand, you do not want GPs rushing to buy just so they can charge fees on FMV rather than commitments. I do not know the answer, and as we act as both LP and GP we understand that there are no simple solutions. However, if we are facing a period of lower returns and if funds continue to invest so heavily in public to private buy-outs, LPs will soon ask very serious questions about why so much of their return is lost in the current typical fee structure.
Other issues relate to how the industry will deal with the credit crunch, the discussion about transparency and tax issues. I think tax systems need to be very careful not to kill the Golden Goose, but, at the same time, the industry itself should eliminate some outrageous tax situations. The cleaners of a company should not be paying more tax than the owner of the business.’
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