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Institutional investor profile: Hamish Mair, Director, Private Equity, Martin Currie

Mair on Continental Europe's future promise, on the risk of one-man bands, on the winners and losers of consolidation, on why track records don't tell the full story and on the weight of money currently in the market.

Martin Currie is an independent investment management company based in Edinburgh, Scotland with $10bn under management. It has been investing in private equity since the mid 1980s. It currently invests in the asset class via the Martin Currie Capital Return Trust, which was launched in 1999 as a major part of the reconstruction of the Scottish Eastern Investment Trust and has £140m under management. Mair has been at Martin Currie since 1990 and has been involved in private equity programmes there since 1992. Previously, he was an investment analyst with Robert Fleming.

What type of investments do you tend to look for?
‘We have a “best of breed” approach. We look typically for funds that operate in the mid-market space. We look for funds with good skill sets and track records in place, but that are not necessarily household names. We describe our selection of funds as a conviction choice. Some will be well known, others will not. We're looking for people who can deliver strong net returns over the medium term.

‘Our fund selection is driven by a top-down process, whereby we have a clear idea of how we would like the underlying portfolio to develop over the next few years. We have target percentages to achieve certain country weightings. The underlying portfolio will develop towards 40 per cent in Continental Europe, 35 per cent in the UK and 25 per cent in North America. We do also have the ability to invest up to ten per cent outside North America and Europe. That gives scope for one or two fund investments in emerging markets, principally Asia.

‘We have a global mandate, but those targets don't represent the index of world private equity. We are closest to the UK and Continental European markets and our intelligence is strongest there. That's why we have over-weighted towards those regions. We do have some links with North America and our shareholder base wants us to retain an exposure to the largest and deepest private equity market in the world, but we recognise our limitations on doing that from here. That's why we have set the allocation at 25 per cent.

‘The growth in the Continental European component is quite a large increase from where we are at the moment - it's currently at around 15 per cent. That is because we see that market deepening and broadening more rapidly than the overall economy. There are various reasons for that: the spread of an entrepreneurial culture, increased harmonisation across the continent, a greater appreciation of equity in the more general sense and the adoption of financial structures that are in place in the US and UK. We will achieve this partly by backing funds that specialise in one particular country or geographical region and partly by backing UK-based groups that are expanding their activities in Europe. We have backed a number of funds in France over the years and we will be increasing the number of those. We're making fund commitments in places such as Germany and we have been monitoring Spain for a while, but haven't as yet committed any money there, partly because the opportunities have been limited. We will also start investing in regions such as Scandinavia.

‘We also have targets for investments by style. We are aiming towards 30 per cent in venture, 50 per cent in buy-outs and 20 per cent in mezzanine funds. All of these will be spread according to our geographic allocation.

‘The whole point about these geographic and style allocations is that the main reason for holding a fund of funds is to control the risk of private equity through diversification. You can have more targeted products, but we think it's important that investors have a substantial degree of diversification. If you misread the cycle, then you can end up with some pretty surprising results.'

What about direct investments and secondaries?
‘We do some direct investments. At the moment, we have about three or four direct investments, which are legacy investments from the Scottish Eastern portfolio. We are managing those out and they will be realised over the next 12 months. We also have some experience of co-investing and we are likely to do more in the future.

‘We are also able to invest in some secondary positions. We have seen good deal flow on the primary front recently, but we have not been actively searching for secondary portfolios. It's something we will do in the future, though. We keep in contact with a number of the key secondary players in case there is an opportunity to work together with them on a transaction.'

What size investments do you tend to make?
‘It varies according to the fund, but the average lies somewhere between £5m and £10m.'

How many investments do you tend to make in a year?
‘It varies according to how much capital we have to commit. But the last 12 months have been relatively busy. By the end of the year, we will have made about ten new commitments. We anticipate investing more than that, so I would say that the ideal would be ten to 15 in a year.'

What do you look for in a private equity manager?
‘We look for clear focus, strong teams and proof of their skills, such as a good track record. Those are the key things.'

What puts you off investing in a fund?
‘We would be nervous about investing in a one-man band. Most groups are led by powerful individuals, but if it really was a one-man band, then that is a pretty high-risk proposition. In our experience, we have found that it can be difficult to keep a quality team together if one individual is too dominant. We also avoid groups that have changed their strategy - or appear to have done. They may have a good reason to have done that and if they can articulate that in a way that makes sense to us, then we will consider them. But we've seen that when a fund diverges from its previously successful strategy, it often goes wrong.

‘If there is anything in the reference checking or due diligence that makes us uneasy, then experience has shown that it is best to avoid committing to the fund. We are also very wary of committing to funds with a very narrow investment focus - they generally end up having to do deals that fit their focus rather than seeking out the best deals and it gives you very poor diversification. We look at the distribution of the carried interest through the fund to ensure that it is equitable. Another key area for us is the terms and conditions relating to the fund towards the end of its life. We like to be able to have some kind of influence on the direction of the fund at that stage.

‘It's all about judging the people. If you are uneasy about them and you don't trust them 100 per cent, then you don't do it. Track record is obviously important. But it's not the be all and end all. It's also not the headline figures that are key, but the background detail. You might find people who have an indifferent track record while they have effectively been learning their trade. That doesn't mean that you shouldn't back them. The less obviously good the track record, the more explanation is required. The other side of it is that you should never take a very good track record at face value.'

What is the biggest mistake that you've ever made?
‘The biggest mistake has been backing someone that I wasn't 100 per cent convinced about. The thing that I have learned is that if there is some kind of mixed signal about a key executive either in a company or in a fund, then you should not back it. There is very little upside in backing a “character”. If you're not sure, I've found that in my experience, it's better not to give them the benefit of the doubt.

‘Other than that, I'd say that our mistakes are historical in that they relate to the early days of the industry, when people just didn't have track records in private equity. It was incredibly hard to judge then how successful an idea would be. There were some good ideas backed, but only some of them were implemented successfully.'

What is the biggest issue in the private equity industry?
‘I think that the weight of money is a problem. There have been a lot of funds raised over the last few years and that money is not evenly distributed among the different types of fund. The issue is that the way in which that money finds its way into deals will have a profound influence on which type of funds do well and which do badly. So, for example, there has been a lot of money flowing into large buy-out funds, but there is not an infinite number of large buy-out deals out there. In the mid-market, where we see quite a lot of opportunity, there is a smaller amount of dedicated money and a much wider number of opportunities. Intuitively, that means the market should be better, but it all depends on the money from the large deals not propping up the value of mid-market deals.

‘There are also issues about fees. With the smaller and medium-sized groups, I don't think that the fees are particularly unfair. With the larger funds, the fees become quite large amounts of money that just come in on a recurring basis. It is possible to run a large fund with a medium-sized group and make some pretty reasonable profits simply from the fees, irrespective of how you make investments. In fact, you can make investments extremely badly and still be very well remunerated. That is wrong and you would be hard-pushed to find a similar structure anywhere else within the investment management industry - most fat fees are made off the back of successful performance. There is a case for fees not being based on commitments, but on the value of investments being made. That way, the fees would grow as the assets grew in value.'

How do you think that the industry will change in the future?
‘Funds of funds will become increasingly professional and that will lead to a professionalisation of the underlying funds. They will become better at communicating with investors. I think there will also be a lot of consolidation of groups. It is possible to run a small outfit, but there are a lot more small, not very successful, outfits out there than there should be. That will take place a little among funds of funds as well. That is a natural progression because fundraising is not easy right now. In general, when that happens in the investment management industry, you see wide-scale consolidation. So you'll see winners and losers in that process, which I think will last a few years, and then you'll see a reversion to spin-offs and other new groups emerging.'

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