PRINT THIS PAGE

Institutional investor profile, Martin Anthonsen, Chief Investment Officer, Nordic Alternative Investment Advisors

Anthonsen on why Nordic spun out of Lansforsakringar, on the importance of alignment of interests, on the scalability of private equity and on why fees will come down.

Nordic Alternative Investment Advisors spun out of the alternative investment department of Swedish insurance company Lansforsakringar AB in September as part of the group's strategy to outsource all of its investment management functions. Nordic has hedge fund and private equity investment experience stretching back to the late 1980s and will continue to manage LF's alternative investments. It currently has E700m under management, although this is expected to grow over future years. The firm is based in Stockholm and has ambitions to provide advisory services to a small group of large Nordic institutions. Anthonsen was with LF for six years working with the company's alternatives programme.

Why did you spin out of Lansforsakringar AB?
‘Over the past few years, Lansforsakringar AB has decided to out source all of its asset management activities. It no longer believes that asset management is a core activity for the group as an insurance business. It concluded that the least risky and most cost-efficient way to manage and develop its alternative asset exposure was to outsource the management of its portfolio to us. For our part, we decided to set up Nordic following several successful years at LF. We wanted to explore the opportunity of offering our knowledge, experience and established relationships to other institutional investors. While we are currently focused on managing the LF portfolio, in the future we would like to provide advisory services to a small number of Nordic institutions.'

What type of investments do you tend to look for?
‘The type of investments that we make will depend very much on the needs of the client. But typically, we tend to focus on what we define as the core areas of private equity: buy-outs and venture capital. In addition to that, we have included growth capital, mainly to make room for a couple of unique US general partners.

‘Having worked for a large institution for many years, we believe that we have a good understanding of investors' needs. We will work hard to communicate to prospective clients that the key to establishing a successful private equity programme is to be truly long term. It sounds pretty obvious, but you can't emphasise this point enough. It is tremendously expensive to switch in and out of private equity. We believe that we can reduce the risk of myopic behaviour and the associated value destruction by establishing a portfolio that produces predictable NAVs (ie, one that has some form of downside protection) and relatively predictable cash flows to the investor. We can do that by investing the majority of the portfolio in mature businesses with predictable, high quality cash flows. As a result, we believe that buy-out funds should dominate most institutional private equity programmes.

‘We also strongly believe that diversification is a way of reducing risk, and so we would recommend committing to a dozen or so managers in each buy-outs and venture capital. Adding any more managers adds very little in terms of risk reduction and may actually decrease returns. By setting this type of limit on the number of funds, you are also forced to choose very carefully which funds you will invest in.

‘We also drill down further to achieve a well diversified portfolio. Within our group of buy-out managers, for example, we work hard to establish a good balance in our underlying investments - we want to achieve a mix of smaller to larger companies. With the amount of money we are managing, I think that it's very easy to invest in just the large buy-out funds. All you need to do is write a large cheque and a large sum of your money is committed. Large programmes are very easily tilted towards very large deals. We want to avoid that.

‘We believe that private equity is not for every institution. Success requires investors to understand thoroughly, or even embrace, the illiquidity and the long-term nature of the asset class. We will not enter an agreement with an institution unless it is clear to us that it has taken all this on board.

‘We take a bottom-up approach to investing, so we don't have specific investment targets according to regions. We search for the best managers in the full range of the market. But at the larger end of the market, we have a greater exposure to Europe and on the venture capital side, we have invested mainly in the US. These patterns are a reflection of where we think the best managers and opportunities are.'

Do you invest in secondaries or mezzanine?
‘We don't have any commitments to secondaries positions or to mezzanine. We have instead focused on what we believe to be the core private equity areas. It's very easy to react to whatever comes knocking on the door. We decided very early on that we wanted to build a portfolio in the core areas and do that to the best of our abilities. That in itself is plenty in terms of the work involved. We decided not to spend time on exploring areas, such as secondaries or mezzanine that may or may not add value to our overall portfolio at this stage. I'm not saying that we will never invest in these sub-sectors, but at this time we simply prefer to focus on areas that will dominate the portfolio over the longer term.'

What are the most promising areas at the moment?
‘We don't generally approach private equity investing with a view on the timing of certain markets or sectors. We think it is very dangerous to try to time markets. It is complex enough to forecast the future anyway, but the time it takes to invest a private equity fund and then to take the portfolio to exit means that you can't go looking for the next big thing. We can't control the timing of the underlying investments and so we think it is very difficult to actually add anything this way. Our firm belief is that we can optimise long-term returns by identifying the best managers in the world by diversifying by geography and sectors. What I would say, though, is that the hurdle for investing outside of Europe and North America is very high. So far, we haven't invested outside these regions, not because we can't but because we haven't found anything that fits our criteria yet.'

What do you look for in a private equity manager?
‘We look for funds with a well formulated, clear strategy that is sustainable over the long term. The managers need to have relevant experience. The firm should be stable with sufficient resources. We look in particular for managers who are religious about not overpaying - paying too much makes it very difficult to make a decent return - and who have a proven ability to improve underlying fundamentals of the portfolio companies during ownership. Managers need an innovative and opportunistic approach to exiting their investments rather than a strategy that relies on market timing. We don't like people who stray from their stated strategy and so we look for strong discipline in this area.

‘We like managers that focus not on time-weighted returns, but on cash multiples. A manager that achieves a good IRR over a short period gives their investors the problem of reinvestment risk. The cash multiples we tend to look for are at least 2.5 times our money in three to five years for buy-outs and slightly more over a slightly longer period for venture capital.

‘Venture managers, specifically, have to have a fundamental understanding of the technology or sector they focus on, as well as a proven ability to spot long-term trends and developments within that area. In fact, this is where we see the largest difference between US and European managers - those in the US are in general much stronger in this area. Managers must also have close access to operational expertise. There must also be a strong urge and a proven ability to create sustainable and viable businesses.

‘The other point - and this is extremely important - is alignment of interest. This should be an issue in all situations where someone is appointed to perform for the benefit of someone else. It is particularly important in private equity, which is a situation in which money is effectively locked up for ten years or more and invested and managed on a totally discretionary basis - that's a unique situation. In our minds, the most effective way to achieve this is that the manager invests a substantial part of his wealth in the fund. The other thing is that the manager's upside should come from both the return on the capital he invests in the deals and carried interest - not from the management fee.'

How much do you think that GPs should invest in their own funds?
‘This is normally presented in terms of a percentage of a fund. We don't think that that is the issue here. Instead, it should be a significant percentage of the managers' personal wealth. It's very hard to get the information on this, but you can always do a reasonable analysis by looking at on previous exits and talking to managers about it. We spend a lot of time trying to understand this.'

What is your appetite for first-time funds?
‘We have no aversion to first-time funds. In fact, several of our best managers were first-time funds when we first invested. But the further away from our own markets that we go, the harder it is for us to assess the managers' backgrounds. We set high hurdles for first-time funds. We would never invest with anyone who doesn't have the relevant experience, for example. By relevant, I mean that they have to have spent substantial time doing related work. We spend a lot of time on attribution analysis. We have to be able to substantiate each individual's track record - preferably through our own channels as it is very difficult to rely on what we receive from the manager. Otherwise, the work we do on first time funds doesn't differ much from that on established groups.'

What is your biggest mistake?
‘We have avoided serious mistakes with our client's portfolio to date. But I suppose that one of the mistakes we made regarding our business was to underestimate grossly the amount of attention that we would receive from various sections of the market. We have had so many calls from people who have asked us why we haven't let the market know what we were doing and some of them have misconceptions about our activities and motives. Our thinking on this had been that we would make ourselves more visible once we had built and established the business. In retrospect, we should have dealt with this more proactively.'

What irritates you about private equity?
‘The fee structure is by and large much more intellectually honest than that in traditional asset management. This is one of the reasons that private equity manages to attract some of the brightest people. What irritates me is when managers destroy this fundamental principle. It is very disturbing to see firms keep the same percentage of management fee when they raise ever larger funds. It's as if there were no scale advantages in this business. We truly want our managers to become wealthy - that is not where the problem lies. But this should happen as a result successful exits rather than through a risk-free management fee. The economics in many cases are just plain wrong.

‘To a large extent, this is true also for the advisory and fund-of-funds businesses. We believe that the winning model for this business long-term is charging a low management fee that is supplemented by performance fees. The most successful organisations will be able to attract capital on a relatively higher performance fee level. That's where the differentiation should lie.'

What is the biggest issue in the private equity market?
‘We expect returns in the future to be significantly lower than they have been historically. Many people are not being realistic about the levels of returns they will receive. Private equity overall will always be closely linked to the public stock markets. I think that we'll see only a small margin over the quoted equity markets for the whole of private equity. You will only manage to achieve substantially over the 500 basis point mark if you can identify and invest with the very best managers.

‘Some of the larger funds in particular will have a hard time delivering in line with their historical relative returns. This is because they are going after more and more contested deals - most large deals go to auction these days. Over time these large firms will have a hard time attracting the more reliable sources of capital - the more informed investors.

‘Again, with the larger organisations, I think they will find it a challenge to succeed in institutionalising the skills and capabilities of the original team as they continue to grow - their ability to create value, their experience and their discipline.'

How do you think that the market will change over the future?
‘Institutions will increasingly move towards outsourcing - that's one of the reasons we set up this business. It makes sense for all parties involved: there are clear scale advantages in managing a private equity fund portfolio. Also it is difficult for institutions to ensure team continuity. For the best GPs it makes sense because it will require less effort for them to raise money. That way they can concentrate on their core business.

‘Fee levels will generally come down. This will come about as a result of pressure from limited partners. There are pockets of investors that raise this issue - mainly the more experienced ones. The pendulum has swung in favour of investors recently.

‘Many of the GPs that set up shop in the late nineties are either already closing down or being taken over. This development is set to continue for a long time.'

Copyright © 2002 AltAssets