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Institutional investor profile, Leif Hasager, Senior Vice President, Bank//Pension

Hasager on why GPs and LPs are over-optimistic about their returns expectations, on the mixed quality of funds of funds, on why some investors shouldn't even bother with private equity and on the prospects for the asset class in emerging markets.

Based in Valby, Denmark, Bank//Pension is the pension fund for the Danish financial services industry. It has DKr7bn under management and earlier this year announced a decision to set its private equity allocation target at 7.5 per cent. The fund invests mainly through funds of funds, but also makes additional investments in distressed debt, mezzanine and intends to invest in opportunistic real estate. Hasager has been at Bank//Pension full time since last year. He previously worked part time for the fund and part time as Associate Professor at the Copenhagen Business School.

Why do you invest in private equity?
‘We undertook a review of our investments with an asset/liability study this year and found that, even with the most conservative estimates, private equity should be a fairly large part of our portfolio over the long term. We revised down that amount to take account of the lack of liquidity in the private equity market. We had already been investing in private equity before that study for about a year, although not significantly.

‘The main reason for us to invest is returns. We are fully aware that private equity is equity in the long run. It is bound to follow the equity markets - albeit with a time lag. But we believe that by investing in private equity we can boost our equity returns. We are realistic about the level of those returns, though. Our return expectations for private equity are 200 basis points over the public markets. That is much lower than most GPs would have you believe they are capable of and it's much lower than most investors aim for - they usually talk about expecting 500 basis points. If you were able identify the top quartile performers with absolute certainty, then you would be able to get your 500 basis points, but I think that is unrealistic in the market anyway, but particularly now that overall equities returns look set to shrink.'

What type of funds do you look for?
‘We have made a couple of fund investments ourselves, but we invest mainly via funds of funds. We have invested in Danish biotechnology fund, for example, and that was our first private equity investment. We do add on to the funds of funds investments, though, in areas such as distressed debt and mezzanine.

‘We have no fixed allocation by geography or stage, but we have an idea of how the portfolio is likely to grow. We expect to be invested 50-50 in the US and Europe and we are likely to be over weighted in buy-outs over venture capital, especially in Europe. But we don't want to set fixed allocations because we believe that we should leave it up to the manager to decide where exactly the best opportunities lie. That's what we pay our funds of funds to do.

‘As a result, we look for either global or regional funds of funds although we are not really looking to gain exposure to emerging markets at the moment. Within those funds of funds, we look at both diversified funds and those that specialise a little more. We have invested in one fund of funds that specialises according to themes, for example, and another that invests primarily in the mid-market.

‘We do not invest directly and we are not looking for secondaries - either direct or dedicated funds. We believe that we will get enough secondaries exposure through our funds of funds investments because many of them participate in the market at least in a small way, anyway.'

What do you look for in a fund of funds?
‘We look for stability in the organisation. We like to see that the key people have worked for the fund for a reasonable amount of time - we don't like to see people leave. We also try to judge whether the people we are dealing with have relevant experience and whether they are able to translate that experience into superior performance. The experience and skills of the team should be broad and varied, so we would look for those that have a mix of business experience, time spent working with a direct investment private equity firm so that they know the business inside out, as well as people who have been in the fund of funds business for a long time.

‘We do look at a team's track record, but we take the view that past performance is not a guarantee of future success, even in private equity. Besides, past performance is hard to gauge with any precision in this asset class. There is not much data available in the asset class generally and there is even less in the fund of funds market. Even when you do get data, you cannot be sure how reliable it is. So we only use track record as a guideline and we don't believe that it is the most important aspect of investing in a fund of funds. Of course, if we discovered that a fund had had some spectacular disasters, then they would have to give us some very good answers as to why they happened.'

How would you rate the quality of the funds of funds that you are seeing?
‘We see a mixed quality of funds of funds. I would say that we would be reasonably happy to place money with about 50 per cent of the funds that we see; we'd never touch the other 50 per cent. We see a lot of people who have only recently come into the industry, they don't have previous experience of fund of funds investing and many of them don't have a clear focus. I think it would be very dangerous to place your money with that kind of fund.

‘The other thing that we see are funds of funds that are part of a huge conglomerate and many of these have obvious conflicts of interest. There are a lot of investment banks that have a private equity arm and they have to grapple with Chinese walls. We also see a lot of funds of funds that also have a direct investment capability and we believe that that creates conflicts of interest. Again, we are very wary of funds of funds that have spun out from being captive and that are now raising money from third parties. The former parent company bankrolls the fund in order to gain co-investment rights. I don't think that the other limited partners in these funds always get a fair share of the deals.'

What advice would you offer to a new investor?
‘New investors should first of all work out how much they should be investing. My advice to them would be that if they were looking at four per cent or under, they should forget about it altogether. Private equity is an extremely time-consuming asset class. You are likely to have to spend at least 25 per cent of your time on it and you won't have enough time to devote to the other investments in your portfolio if you are only looking at investing a very small proportion of the fund. And despite all that time spent, it is also unlikely to make that much difference to your overall returns if you are investing under four per cent.

‘If we are talking about absolute numbers, those investing E200m or less should go the funds of funds route. That is the only way to get a good spread of investments for such a small amount.

‘Don't believe that you will get 500 to 1,000 basis points over the public markets, no matter what the managers tell you. Be realistic about the level of returns you will actually get.

‘Understand, too, that private equity is illiquid. If you are likely to need cash quickly at any point in the future, don't put it into private equity. It also takes time to build up a private equity portfolio. Don't invest all your money at once. You need good vintage year diversification to succeed in private equity investing. It will probably take us many years to get up to our full 7.5 per cent allocation.

‘Consider private equity to be part of your overall equity exposure, rather than as a totally separate entity. That will help you decide where to invest your money and ensure that you get the exposure you want over your whole portfolio.

‘And lastly, be aware that manager selection, while being crucial to your investments' success, is extremely difficult. There is a real lack of information to help you reach your decision and the information that you do receive is very often of very poor quality.'

What irritates you about private equity?
‘There are a couple of things that irritate me. One of these is the nature of capital calls. You get absolutely no notice for these. I wish the industry would make fewer calls to their investors and give them more advanced notice.

‘Reporting is another one of my bugbears. We get sent pages and pages of documentation and information. That is not helpful. It is voluminous and it is not transparent. I could sit there for hours looking for the actual figure that I need - and even then fail to find it. Firms need to realise that providing a telephone directory of documentation is not transparency; providing user-friendly and timely information is. The reports should to be sent to investors electronically rather than in a paper document and they should be sent in a standard format. That way we could automate our processes. I don't understand why this doesn't happen already.'

What is the biggest issue in the industry?
‘I think there are two main issues. The first of these is the hangover from the late 1990s and 2000. There are many bad investments still lingering in many managers' portfolios. If they are not careful, then these investments will eat up too much cash and take up too much time in those specific funds and in subsequent ones, too.

‘The second is the capital overhang. Despite the fact that some firms have handed money back to their investors, there is still an enormous amount of uninvested capital in the system - both in the US and Europe. I worry that many managers, under pressure from some of their GPs, will be too eager to invest at too high prices, even now. This has certainly been happening recently and I think we'll find that this is the case with some of the large buy-out transactions that have taken place over the last few months.'

How do you think that the market will change in the future?
‘I don't think that the US market will alter much. It is already well developed and is unlikely to change dramatically. The European market still has some way to go. It will develop further as the fund managers gain experience and as institutional investors start feeling more comfortable about private equity as an investment option. I think we will see more of them investing in the asset class because they will increasingly be looking for investments that can boost their overall returns as public market returns fall over time. They will also be attracted by the fact that private equity shows far less short-term volatility than public markets - a problem that many institutions are having to deal with now.

‘I'm not sure what will happen to the other, emerging markets. They may develop, but investors will have to be sure that political and legislative risks are minimised in these countries. I've seen people who invested in China being forced to sell at a massive loss. A whole legislative framework needs to be put into place in countries such as this so that investors actually own what they think they own and so that they are able to repatriate their returns - the point, after all, of investing in private equity. The other issue, of course is that these economies need quality managers, which don't just appear overnight. Some of the more experienced US managers are moving into some of these territories, but they are mainly pioneers.'

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