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Institutional investor profile: Colin Wimsett, Managing Director, Europe, Pantheon Ventures

Wimsett on never saying never, on box ticking, on avoiding the cookie-cutter approach to investing, on the evolution of control and strategy in private equity firms and on why venture capital is not a one-way bet.

Headquartered in London, Pantheon is a global fund of funds with offices in San Francisco, Hong Kong and Brussels. It has over $5.5bn under management, invests across all stages and, in addition to its more traditional fund of funds activities, also has secondaries funds. Wimsett joined Pantheon in 1997 from the West Midlands Pension Fund, where he spent nine years focusing on its private equity investments.

What type of investments do you tend to look for?
‘We have different strategies according to the different regions. In the US, for example, we have a higher weighting towards venture capital than we do in Europe because it is the largest and most successful venture capital market in the world. Typically, around 50 per cent of our clients' programmes will be in the US in both venture and buy-outs, 40 to 45 per cent in Europe, predominantly in buy-outs, and the balance in global or Asian funds, depending on the client's appetite.

‘In Europe, we would typically be looking to give clients an exposure to a broad range of opportunities that are available in the different markets, but we would under- and overweight certain areas within those markets. So, for example, we have been underweight in venture capital historically. We actually increased our allocation to VC in Europe in 1997, but we didn't invest any money between then and 2000 because we felt that the timing was wrong. We saw all the signs of the emergence of a bubble and we couldn't get comfortable with implementing that strategy at that time. We do set our strategies within long-term parameters, but we will vary that over the short term if the climate doesn't appear right.

‘Now, actually, we are probably in the reverse situation in that other people have stopped investing in venture and we have started. It's still only a small part of our clients' overall European private equity exposure at ten to 15 per cent, but we believe that it is better implemented now rather than four or so years ago, subject to identifying good managers that are not too troubled by their existing portfolio companies. We believe in the long-term fundamentals of the venture capital market both in the US and in Europe, but Europe isn't a proven market yet - and it's impossible to say how long it will take to reach that point. There are moves in the right direction, in terms of increased entrepreneurialism, an improved legislative environment, and the opening of the junior markets (even if they have stalled for now). In the US, venture is proven. It may be going through a difficult time at the moment because of the volumes of money that were invested between 1998 and 2000. But it will come back. Venture has been through those cycles before and we have great belief in the depth and strength of the market.'

‘One of the key things that I have learned about private equity over the years is that the time that everyone else is stopping doing something is actually the time when you should be investing.

‘So in Europe, our main focus is on mid-market buy-outs and we underweight very large buy-outs. This is because the very large buy-out market is much more transparent, has had a lot of money poured into it, and there have been a lot of new entrants to the market from the US. It is by and large an investment bank auction-led market. Those who win deals in that market pay the highest price based on information they have gleaned from the auction process. We like the mid-market because it is much less transparent, there are opportunities for managers to do a lot of due diligence in advance and the transactions are not always completed on the basis of the highest price being paid. So we believe that that market will generate higher returns.

‘We don't have an active policy of co-investing, although we do the occasional direct investment in Europe when something particularly exciting comes along from an existing manager. We've done two over the last couple of years, for example. It's not something that we actively seek. And we would only do it alongside one of our GPs - we are not seeking to compete with fund managers.'

What is your appetite for first-time funds?
‘Our US funds have actively pursued a strategy of investing in emerging managers, but we haven't focused so heavily on that in Europe. The US market is much more mature and the firms have had a lot longer to grow and produce credible spin-outs. There, spin-outs come from funds that we have followed for a long time, so we are able to see which executives have done which transactions and we can track performance in a meaningful way.

‘In Europe, we haven't allocated a specific amount to emerging managers because the immaturity of the private equity market has meant that there haven't been many. We do, however, expect them to start happening now. The biggest firms in the industry now have 100-plus employees, their strategies may have changed quite dramatically over recent years and you can usually expect to see spin-outs from those types of firms. As that starts happening, we will have a specific allocation to emerging managers.

‘We do look at and invest in first-time funds, but so far, many of the funds that we have seen have tended to be one-man bands or been made up of people who are not particularly high profile or who hadn't worked together before. We wouldn't do those types of funds.'

How do you find out about good opportunities?
‘Resources and experience are key to this. You need to have people on the ground. It's our policy to know all the credible players in the European marketplace. According to the latest EVCA figures, there are over 1,000 managers in the market. We have a very extensive database that tracks 932 of those managers - all those that raise external money. Of those, there are firms that will not raise another fund or that have very micro strategies. There are well over 100 managers in Scandinavia, for example, but many of them wouldn't be ones that institutional investors would be interested in because they are focused on a very small area. So there are about 500 that meet typical institutional investors' criteria. We would be looking to know, meet and have a relationship with all those 500 managers at varying degrees of depth.

‘We tend to invest in between 20 and 25 funds over a three-year period. So we'll be looking to invest in the best manager in each niche of the market.

‘We have an open door policy at Pantheon. We seek to meet all the managers. That's a vital part of the process. You have to be proactive, you have to identify all the managers out there ahead of their fundraising. We also seek to have done a lot of the due diligence before those 20 to 25 managers start out on the fundraising trail. That gives us the ability to use the depth of experience we have here. Most of the senior people here are then able to be involved in the process and meet the fund managers. That way, we can come to a consensus view. Tracking managers the way we do also enables us to see the fund managers over a number of situations and over a period of time - we can see whether they are consistent.

‘It means that we can invest in a fund's first closing, too. We prefer to do that because we then have some influence over the terms and because we can ensure that our clients' money is invested in the best funds, where there can be access issues.

‘The other thing is that, because we know when firms are going to be out raising again, we avoid having to rule out funds that we would like to invest in simply because we are already overweight in such and such an area. Obviously, we can't predict where spin-outs are going to appear, but we know all the established players and we know where they invest. We have a plan for those 20 to 25 investments. It's not like direct investing in which you don't know where or when the next opportunity is going to crop up. At the fund level, the approach is much more structured and organised than that.'

How does you investment process work?
‘We are continually having meetings with fund managers and the whole European team reviews these funds on a monthly basis. We then make decisions on those opportunities and get back to the individual fund managers. If we do want to pursue a fund investment, we create a deal team drawn from our European investment professionals and we would also involve a number of senior partners in the process.

‘The policy tends to be “a quick no and a slow yes”. We believe that most managers tend to respect and like this approach. They don't like being messed around or misled. If we think we are unlikely to proceed with an investment, then we will get back to them early on. If we do want to proceed then it will take us a long time - that's why we start work so early.'

What do you look for in a private equity fund manager?
‘We are essentially trying to achieve sustainable high returns for our clients. The starting point is to look at the management team and the organisation structure. Private equity is a people business and that is where the main risks normally lie. We look for a stable management team in which the economics are aligned with the clients. We look for teams with outstanding records of achievement with some proprietary advantages in terms of deal flow and access to transactions. We don't like teams that are reliant on the auction market.

‘We look for teams that have a well thought out investment strategy that is evolving in line with the changes in the market place.'

What puts you off an investment?
‘There are not many things that would automatically cause us to strike a fund from our list. We generally say “never say never” - you can quite often work through the minor difficulties. But there are things that are unacceptable to us. One of those would be serious conflicts of interest, such as a fund where the managers can cherry pick among the transactions. Another would be a pure first-time fund - one managed by people who have never worked in private equity before or who have never worked with each other before. We'd be very unlikely to invest in a fund like that.

‘By putting managers through such a rigorous selection procedure we will spot any major problems early on and say no to them. We also don't have a box-ticking mentality, private equity doesn't work like that. This is an opportunistic, entrepreneurial business. So we don't really have a list of “no-nos” or strict rules.'

What advice would you offer to a new private equity investor?
‘The most important thing is to go into it for the long-term. People forget that private equity is a long-term asset class. Don't follow fashions. This is a feast or famine industry. It's also very cyclical. You can't judge particular cycles ahead of time so the only sensible way to invest is to have a long-term strategy and invest consistently over time. As we have seen from recent experience in the venture capital space, that can do incredible damage. It's also always important to minimise conflicts of interest and to focus on that as a key area.

‘It's important to recognise, too, that you don't know everything. There have been a lot of mistakes made in the industry by people who have gone into private equity thinking that they knew it all.'

What is the biggest mistake you have ever made?
‘I think that my biggest mistake was a missed opportunity. I did a research paper on Scandinavia in 1990. I didn't see how the market was going to grow. The conglomerates were being forced to through a huge restructuring phase - they had previously been built up in a very benevolent environment and restructuring was the only way of dealing with the heavy recession they were going through at the time. At the same time, the banks were in trouble and there was a shortage of capital. That was a superb time for private equity. I just didn't foresee that opportunity - although Pantheon did. I focused instead on the fact that it was a new market and that there weren't private equity managers around with a track record. I learnt from that that it is possible to make money in new markets if the conditions are right and that you shouldn't have a cookie-cutter approach to looking at any market.'

What irritates you about private equity?
‘I get irritated when I see that there has been a breach of investors' trust. This is a people industry and investors make long-term commitments to funds. It is possible to build certain levels of protection into the agreements, but there is always an element of trust. You can't provide for everything that is going to happen over the ten-year life of a fund. So it irritates me very much when managers abuse that trust. You see funds that lack transparency and fund managers that act very much in their own interests rather than in those of their investors.'

What do you think is the biggest issue in the market?
‘I think there are two big issues. I think succession and the evolution of control of the very large firms that dominate the industry need to be dealt with. Many of the firms that started out in the 1980s and that were very small to begin with were not structured in such a way that they could easily become large organisations. They have been led by people who have now become wealthy beyond anyone's expectations. These people are now reaching retirement age. Some firms have managed to deal with the succession issues well by passing on knowledge, carry and control. But there are others that haven't and are still dominated by their founders. Many of these firms will see key executives leave because they are the people that are now doing the work but not receiving the rewards for it. I also think that most private equity managers are entrepreneurial and like to run their own show rather than work in institutions, managing a huge machine.

‘The other issue is evolution of strategy. The market has changed dramatically over the last ten years. In the early 1990s, there were a lot of opportunities for the buy-out market to make money by buying businesses at a very attractive price outside the auction market and selling at much higher valuations when the markets picked up. The world is no longer like that. Auctions have crept into the market, pushing prices higher. And even when you don't have to be the highest bidder to win a deal, you have to do a great deal of work with a company to make good money. Firms have to deal with the fact that holding periods are much longer and they have to add value through strategies such as buy and build. Absolute returns are going to fall and people are going to have to adapt to this new environment. You won't see many quick flips in future. The markets are more mature now. It's difficult because when you look at track records, they are based on performance in a very different environment. It means that you have to question how relevant those track records are to today's market. Looking at past performance is only of limited value.'

How do you think that the market will change in the future?
‘The buy-out market will continue to grow as opportunities arise from the restructuring that's happening across Europe. That will provide an increasing flow of deals. Buy-outs will continue to produce good returns in all areas of the market. Absolute returns will come down, but relative returns will remain attractive. As the market becomes more competitive, firms will become more specialised in attempts to find different types of value-add. The industry will continue to go through difficult times. It always has. But if you look at some of the harder times, such as the early 1990s, you see that that is the time that investors can get the best returns.

‘We believe in the long-term success of the venture market. But it will go through a tough period in the short to medium term. It is going to be difficult to raise money, it's going to be difficult to realise investments. It's a return to the basics of venture capital, which was the foundation of the industry in the US, looking at outstanding technology opportunities and helping those companies develop and grow on a long-term basis. Venture capital is not a quick-flip market driven by hype as people saw it in the late 1990s. It's not a one-way bet. It's back down to the long-term fundamentals and that is the key for success.

In terms of the industry as a whole, I think that private equity will become a fully established asset class. It will be unusual for pension funds and insurance companies not to have an allocation to private equity. The secondaries market will continue to develop - that will be healthy for the industry. Once there is increased liquidity in the market, it makes it that much easier for the industry to establish its credentials among investors.'

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