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Institutional investor profile: Luigi Santambrogio, Managing Director, Brederode (UK)

Santambrogio on why secondaries may not be all they're cracked up to be, on the advantages of co-investing, on why private equity is more art than science and on why he hopes the asset class remains an inefficient market.

Brederode is a Euronext-quoted investment company, capitalised at around E800m. It actively manages a portfolio of listed and unlisted investments, of which 25 per cent is in private equity. Brederode has been investing in private equity since 1992 and has offices in Waterloo in Belgium and London. Santambrogio has been with Brederode since 1995 when he joined from Prime Lipper Asset Management, based in New York and Milan.

Why did you decide to invest in private equity?
‘One of the reasons was to provide diversification from our public equities investments. But we also decided to invest in private equity because we believe that it provides superior returns over a long period of time. I don't think that you can approach private equity with a short-term attitude. It takes time to build up a good private equity portfolio and it takes time to reach the point where the investments are self-financing. Over time, it should give you excellent returns. But the key thing in this asset class more than any other is to focus on the best managers. That's the reason we invest the way that we do at Brederode. We don't have a set asset allocation according to countries or to sectors. Instead, we go for those we think are the best managers. They don't go out fundraising every year and they don't come knocking on your door. You have to go out and look for them.'

Where do you invest?
‘We started out investing in private equity the US in 1992 because it was the largest and most liquid private equity market. We also started out there because of the backgrounds of people from Brederode - we all have experience in America. We felt comfortable going there to begin with. We started investing in Europe in 1996.

‘Today, the split of our investments is around 50 per cent in the US, 40 per cent in Europe and ten per cent in the rest of the world, which we invest in an opportunistic way. We have a very small exposure in Asia and in Russia. In a market like Russia, you just have to be very patient. Things are looking up, thankfully, but it has had its ups and downs. Our main focus, however, will continue to be on the US and Europe.

‘In terms of stage, we have roughly 80 per cent invested in buy-outs and 20 per cent in venture and telecommunications. But we are value investors and so it is not much of a surprise that buy-outs make up the bulk of our private equity portfolio. Within those buy-out funds in Europe, we tend to invest pan-European players rather than local ones. We are committed to between 20 and 25 managers, although the number of funds is higher.

‘We have not invested in secondaries funds so far. I'm not sure that the returns on secondaries are as good as those you would get by investing directly in buy-out operations, although cash tends to come back faster. I also think that there has been a lot of money invested in this area of the market lately and that's not necessarily a good thing. But it is a good thing for the market as a whole to know there is a liquidity option. It comes at a price, though.

‘Overall, we have been very pleased with the way our investments have gone. We've seen exits at multiples of about two times invested capital, after an average of 28 months and we've seen around a 45 per cent IRR. We realise, however, that that is not sustainable over the years to come.'

Where do you expect to be investing in the future?
‘We are debating at the moment about whether we will invest more in Europe in the future. If we see more good quality managers coming out of the region, and they are offering better propositions then we will invest more in Europe. I think that the market is developing quite well. You're already seeing a good breed of managers here and, in fact, there are a number with long, established and strong track records. That's generally what we are looking for: managers that have been around for some time and that have a good track record. The key thing for us is that managers not only add value to investments, but that they can also exit well - that's especially important in today's climate.'

What else do you look for in a private equity manager?
‘We look for cohesiveness in the team - we like to see teams that have worked together for a long time and that know each other well.

‘I think that the way in which a manager adds value is very important. There are different approaches to this. You can have a manager that is very good at going into a company, changing the management, becoming very active in running the business and turning things around. But others are content simply to back the management and can provide help with strategy and financial input. Their philosophy is to free the management from the chains that have bound them previously if they were part of, say, a conglomerate. That's another way of approaching the value-added proposition. Both approaches can be good as long as the managers make clear what their strategy is. What would worry us is if a manager told us that they like to get involved and then they didn't take a very proactive stance towards their investments.'

How do you tend to find out about private equity investments?
‘We tend to re-invest with funds that we have committed to previously if we they have achieved our objectives. If you have relationships with too many managers, then it becomes impossible to monitor them properly. This is especially important in private equity because it is a people business. You have to know the people that you invest with very well because you have to be able to trust them.

‘We have a number of sponsors who provide input as to funds that are in the market. We also talk to other investors and that can help us source funds.'

What is your appetite for first-time funds?
‘The issue of first-time funds is a tricky one for us. We generally tend to look for established groups made up of cohesive teams that have a good, established track record. Obviously, those things aren't there with a first-time fund. But we might look at some, usually where there is a particular angle.'

Why do you do co-investments?
‘Co-investments are quite important for us. By co-investing, we get to know general partners even better. We get to see the way they work, the way they think, the actions that they take. The reporting you get as a co-investor is quite important because it gives you an idea about how the firm adds value to the overall company and you get to know the company itself better.

‘We generally ask for co-investments rights when we invest. There is sometimes a minimum co-investment that you have to make and in those instances, we pass on that because the amount co-invested would sometimes almost match the amount that you put into a fund. Otherwise, we always like to be considered.

‘We have also done some direct investments, but that is only a very small and limited part of our portfolio. We have only really invested directly in areas that we know a lot about - insurance, for example.'

How does your investment process work?
‘The first step is to look at the PPMs. We have a team of four people: three in Belgium, plus me in London. We each review the PPMs and decide which of the propositions are worth pursuing. The problem is that we have a limited amount of capital to invest. There are many good opportunities out there and we can't invest in all of them.

‘So the ones we decide to go forward with, we screen and we meet with the principals in our office in London and in Belgium. The actual process depends on the type of manager we're looking at. If we are looking at a manager that doesn't have a very long track record, we would spend a lot of time examining the cohesiveness of the team, how long it has been together, their background - very much the people issues. If the team is more established, we would spend more time scrutinising the performance and working out whether they can achieve what they have achieved in the past.

‘The due diligence is extremely important because you are investing for ten years or more. You have to be very sure of what you are getting into. You have to review the due diligence pack that comes with the PPM, but you also have to meet as many of the team as possible. You have to see how the team works. I would be very unhappy if I invested in a fund and then saw it disintegrate a few years down the line. One way of assessing whether this is likely to happen or not is to look at the way the carried interest is distributed among the team. We like to see a broad spread of carry rather than a compensation scheme that is geared to rewarding just the top management. There are still plenty of funds where this is the case.'

What are the main barriers to investing in private equity?
‘One of the main barriers is that you can't build a private equity portfolio overnight. It takes time to know the players, to know how to source the deals and to know how to evaluate the deals. Private equity investing is more art than science. It has a very strong human element that you don't find in listed equities. You also need to be patient because you don't see returns very quickly. Investors need to take a long-term view and not all of them do.'

What is the biggest issue in the private equity industry?
‘I would say that exits are the biggest issue at the moment. A lot of money has been invested very quickly over the last few years. But since the slowdown in the stock markets the lack of appetite for IPOs and the disappearance of the M&A market have meant that exits have become extremely tough to do. People who tried to raise money without having exited any investments from their previous fund have found life pretty difficult. There have been some attempts at bringing private equity-backed companies to IPO and some have been successful, other recent ones haven't, so an effort has been made to address the issue.

‘More exits are starting to happen, but it's a very tough environment. Those that can exit well may not get the return that they had originally been expecting, but they will be the winners of the future. It's a good sign for investors.

‘I also have some concerns about the mega-funds, which is why we tend not to invest in them. When funds get very big, they become inflexible. Being flexible and nimble and fast are necessary qualities in private equity. They do very large deals, they take a long time, there is a lot of competition for the deals and the returns tend to be lower on these mega-funds. There are exceptions, but that is generally our attitude towards them.'

What is the biggest mistake that you've ever made?
‘Right now, we have 13 per cent invested in venture - all in the US. The question is: is that too much? A couple of years ago, you might have asked whether 87 per cent was too little. The main issue for us was that when we looked at those managers we have invested in, we liked them because of their strategy and their performance. We met some of them about a month ago and we are still impressed with the job that they are doing. As always in private equity you will measure your success or failure over a long period of time.'

How do you think that the market will change in the future?
‘My impression is that there have been a lot of new private equity firms springing up over the last few years. Some of them may survive, but I think that many won't. Many will end up being merged into larger firms. And again, I think that the partnerships that manage to achieve good exits will be the ones that survive and do well in the future.

‘On transparency, I think that the information that general partners provide to their investors is generally quite good, although there is always room for improvement. But I think the key issue here is the valuation of portfolio companies. There are guidelines, but it's tough because there is always going to be some element of judgment there. I don't think that it's an issue that will easily be solved. In a way that is a good thing because I don't think that the market would benefit from too much standardisation. One of the good things about the private equity market is that it is inefficient and lacks transparency - that's why the potential for good returns is there.'

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