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Institutional investor profile: David White, Treasury Manager, BOC Group

White on why private equity jargon makes people suspicious, on why chopping and changing in private equity causes problems, on why private equity's high level of fees causes difficulties for pension funds and on why hedge funds are a no-go area for BOC.

The BOC Group is one of the world's largest gases companies, with 43,000 employees. Its pension fund has had a very small exposure to private equity since the late 1980s. Following an asset-liability study, it is currently considering investing up to 15 per cent in alternative assets, including up to five per cent in private equity. White has been with BOC for 26 years and for much of that time been managing the relationship with the pension fund's external investment managers.

Why did you start investing in private equity?
‘Our initial exposure occurred in the same way that many pension funds started investing in private equity - via the private equity arm of what was then Mercury. We had a conventional, balanced mandate with Mercury. They suggested that we put a small percentage of the fund into one of their unquoted security trusts, so we invested in MUST 2. The overall performance of the fund has been very good. The only problem is that people tend to focus on a couple of early disasters rather than the subsequent success of the fund.

‘Our rationale for investing in private equity now is rather more defined since we have completed our asset-liability study. We are investing to boost our overall returns a little. Our target return is at least two per cent over public equities. We're not looking at private equity for diversification reasons - I think that recent experience has shown that private equity offers very little diversification from public markets - the difference appears to be the time lag caused by the method of valuing private equity'

How have your trustees taken to the idea of investing more in private equity?
The trustees have still to be taken through the advantages and disadvantages of private equity. The investment committee has reacted pretty positively. I think that is partly because we would invest via funds of funds rather than investing directly in the funds themselves. The committee feels that this would offer a level of diversification that it is not possible to gain by investing directly. Having said that, I'm not sure that we would be able to get an extremely high degree of diversification because we have just five per cent of the fund to invest - that isn't a huge figure compared with many other investors. I also think that we would be much more comfortable using a gatekeeper to make our investments so that the burden of choosing who to invest with doesn't fall on our shoulders. We have recognised the fact that we haven't got the skills in-house to decide who is a good private equity manager and who isn't.'

What type of diversification are you looking for?
‘With the amount that we have to invest, I can't see us investing in more than two funds of funds. Beyond that I think that our preference is likely to be to diversify by geography. I don't think that we will be specifying what stage of private equity we will be investing in, but the general view is likely to be that we get as wide a spread as possible of venture capital, buy-outs and other stages of private equity.'

Will you be looking at hedge funds?
‘We will not be investing in hedge funds - that's the recommendation of our investment advisor, who doesn't believe the returns currently being quoted are sustainable, and has a problem with the lack of transparency of hedge funds. Why should you invest in hedge funds when the likelihood is they are doing something that if you knew what it was, you wouldn't let them do it? That may be a bit dismissive, but it's a brave pension fund that listens to its advisor and ignores his advice.'

What impact has the Myners Review had on your decision to invest in private equity?
‘The reality of it is that 90 per cent of Myners is common sense and good practice and there is a tendency to concentrate on the ten per cent you don't like, and to slate it. It is not Myners that drives us, it's the consultant who recommended private equity. In all honesty, looking at the results of the asset/liability study, by taking five per cent out of quoted equity and putting it into private equity, you're not going to make a whole heap of difference. It should improve returns and reduce risk, but it really is pretty marginal.'

How will your investment process work?
‘We would start with a long list of funds of funds recommended by our investment advisor. We would send out a request for proposal to all of them, evaluate the responses and shorten the list a bit. We - possibly two or three of us from the investment committee - would then go and see four or five of them. The next stage would be to come down to two or three potential fund of funds managers and then we'd hold a beauty parade with the full investment committee. The committee would then make recommendations to the trustee. '

What will you be looking for in a gatekeeper?
‘A few things spring to mind. First, the gatekeeper will need to be a “name”, a market leader. We want to choose a gatekeeper who will always get the first call. A good fund of funds manager has no need to make lots of phone calls - people come to him. The second one is this: how does the gatekeeper allocate investments to investors. There are only a few top-performing funds, after all, and we want to be invested in them. If a gatekeeper also runs segregated accounts for funds that are larger than ours, how does he decide whether the investment goes into the segregated portfolio or into the fund of funds? It matters that you do not come second all the time.

‘Another issue is whether they co-invest. It is positive in a sense that they are putting their money where their mouth is, but then it does drag you back to the question of conflict as to who comes first.

‘I also worry about other conflicts of interest. I suppose that if your gatekeeper is a large financial conglomerate, you need to satisfy yourself that he is not shovelling private equity opportunities at you to make money elsewhere. As a result, I think that our preference would be to go with more independent gatekeepers rather than those affiliated to large financial institutions.'

What irritates you about the private equity market?
‘Fees. They irritate the hell out of me. I appreciate the fact that private equity has to be more expensive for investors than some other asset classes because of the nature of the investment. But fees are excessively high in private equity. I know the response from the industry is that you have to look at the returns after the fees have been deducted, but that doesn't stop trustees balking at the amount they are paying the managers.'

What is the biggest issue in the private equity industry?
‘The obvious issue is liquidity. The secondary market appears to be developing and there has been a lot of talk surrounding whether it will provide the liquidity that investors need, but it is a bit thin and expensive if you are the vendor.

‘But liquidity isn't a huge issue for us in private equity. It would be only a small percentage of the total fund. Most of the fund would still be invested in liquid assets, so if you have got five per cent in something illiquid, it doesn't really matter. As long as you are committed to private equity over the mid-term I really don't see any problem. If you chop and change your mind, try it for three years, then get out, that's when you might have a problem. Pension funds really ought to be thinking along much more long-term lines than this anyway.'

How will the private equity market change in the future?
‘Many people's first experience of investing in private equity was unfortunate and people need to enjoy good returns for a while. I don't think that enough funds have invested in private equity for long enough yet for the good news to be widely known and accepted.

‘The impetus provided by Myners will help and we're already seeing many more funds looking at private equity. I also think that there is a level of mistrust among some investors about private equity. The numbers from the British Venture Capital Association will help to remove some of those suspicions, but their credibility needs to improve too.'

What can private equity managers do to earn investors' trust?
‘Private equity and the process by which the managers make money needs demystifying. I am not sure that it is that complicated. How do they decide what the best structure is? How do they decide what their participation in the company is going to be? Where do they find management teams from? How does the business survive if people leave? How do you decide when it's time to take an investment to market or sell it?

‘There is also a lot of jargon in private equity. That always makes people nervous and suspicious. If it appears to be like a black box, and people don't understand it, they won't go near it.'

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