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Institutional investor profile, David Chamberlain, Managing Director, Private Equity, Unigestion

Chamberlain on why investing in a private equity fund is similar to investing in a public company, on the lack of clarity in portfolio valuations, on the importance of acting quickly when things are going wrong and on the potential influence of hedge funds on private equity.

Created in 1971, Unigestion is a listed alternative asset manager for European institutions. The firm is based in Geneva, but it also has regulated offices in London and Paris. It has E3.5bn under management, of which E1bn is in private equity, half of which is in fund of funds products, the other half in institutional mandates. Unigestion clients include the pension funds of Nestle and SwissAir, Baloise Insurance, HSBC Guyerzeller and the Swiss Post Office. The firm has been investing in private equity since the 1980s. Chamberlain has been with Unigestion for 15 years as finance director and subsequently as head of private equity. Before that, he worked in investment and financial management in the UK, France and Switzerland.

What type of investments do you look for?
‘The investments that we look for are largely dictated by the needs of our clients and by the level of value that we can bring to our clients. They are looking for good, long-term returns. I don't believe that they are looking for high volatility or the risk of loss. We try to build portfolios that reflect the right balance of risk and return.

‘We focus on the core markets of Europe and the US - that's where we have expertise. We don't have the expertise to invest outside of those areas, so if our clients are looking for exposure to other markets, then we would advise them to hire specialist fund of funds managers who do have that expertise. We have a very focused approach to managing our portfolios - we are not an index manager and so we are not seeking to get 50 or more funds into the portfolio. That means that we can afford to be extremely selective in the funds that we choose. That allows us, even in the US market, to make strong value judgments.

‘In Europe it is important to have a base in London. That's where most of the private equity firms are based, as are the lawyers and the mezzanine players. It will remain a European focal point for private equity - most of the US firms that invest in Europe have established themselves here. We also believe that we have a lot to gain from our presence in the second-largest private equity market in Europe, and that's France. Cultural business practice is very different from that in the UK and we have experience on the ground there.

‘We invest from small, mid-sized buy-outs through to the large, pan-European funds. I don't think that there is a magic solution to the type of buy-out fund that you invest in. We don't believe that large buy-outs per se are any better or worse than mid-sized buy-outs. We think that there is value to be found in all areas of the market. Our role is to try and create a balanced portfolio that will draw on the best players in the various segments. We do, however, try to avoid funds that sit somewhere in the middle or on the outskirts and that don't have competitive qualities.

‘We have also been reluctant to invest in venture in either the US or Europe. With hindsight, that means that we have been very lucky. The temptation was certainly there in 1999 and 2000, but we held back. As a result, we have a very limited exposure to venture - it's between ten and 15 per cent. In that ten to 15 per cent, we have experienced some pain but on the whole, our portfolios have held up very well and we have strong, positive performance to the end of June 2002 despite the write-downs that have taken place in the market. However, we are now reviewing venture capital again. There is more clarity in the market now than there has been for some time. We are taking a fresh look at venture capital with a view to perhaps committing to some US and European funds.'

What's your view on the secondaries market?
‘We have a dedicated secondaries fund. But we also use secondaries to add value to our primary portfolios. You have to be very careful about the secondaries market. I believe that there is huge potential in the secondaries market, given the amount of capital that is now invested in private equity. Investors are increasingly looking for better liquidity and so there is a real demand for secondaries. Many institutions that get into private equity are frustrated by the fact that they have to wait five or more years to get that exposure and they also need almost current income. Secondary investments can provide fast exposure to a number of funds as well as early returns. So far, our approach has been to attempt to get value from secondaries investments, which is a little different from trying to gain cash exposure to the market. So we don't get involved in auctions if we can help it - we certainly shied away from them in 2000 and 2001. We have focused on buying small positions, principally in the Swiss market, where you have a large private banking industry and many private individuals who invested in private equity and who are now selling their investments. But we do recognise that institutions will need to increase their cash exposure and so we will be looking at other types of secondaries.

‘I think it remains to be seen what the performance of those secondaries done in 2000 and 2001. Private equity valuations have come down substantially and they will probably continue to come down. The prices paid then will have prove to have been very expensive in today's market.'

How does your investment process work?
‘Our investment process has developed over the last ten years. It is critical to the efficient running of our business. There are over 1,000 private equity firms in Europe and we recognise that we cannot possibly see all these firms. We want to use our resources in the best possible way. You can run a business such as ours along two lines: you can either employ a vast army of young and inexperienced analysts to trawl through all the firms in the universe or you can have a very well structured, disciplined investment process run by experienced professionals. We favour the latter approach.

‘The first step in our investment process is to try and have a view on the different markets and the sectors within those market and the sub-sectors. We carry out annual reviews into the different areas. We attach great importance to these reviews because they help us understand the attractiveness of different sectors and the dynamics of the different markets. It means that we are not going to dedicate our valuable time and resources to areas that are not critical to our allocations. We do this research by talking to people. So for buy-out research, we'll talk to the mezzanine houses, to the lenders and the corporate finance houses to understand the opportunities within that sector. That also helps us identify the ten or 15 firms that are considered to be the best in those sectors. That points us in the right direction.

‘This approach imposes a discipline to be patient. If the very best managers in a given sector are not going to be in the market for the next two or three years, then we owe it to our clients to wait until they go out fundraising again.

‘So the reviews point us in the right direction. The rest is rather like an industrial process, which captures the funds in which we have an interest. We filter those through to leave a small group that we would invest in. I guess like other established fund of fund managers, our investment process is very complete. This includes use of extensive data bases, due diligence questionnaires, quantitative value decomposition work, on-site visits, company checks, reference checks, independent legal and tax reviews and so on.'

‘The final part of our investment process is to gain approval from our investment committee. We have established an independent investment committee made up of successful entrepreneurs and businessmen who make the final investment decisions. That complements the thorough day to day due diligence on funds by adding an extra check done by set of a totally separate and independent eyes. In the end, we try to use quantitative analysis and financial modelling to complement our business experience and common sense in making investment decisions.'

What do you look for in a private equity manager?
‘Our ultimate objective is to achieve strong, long-term returns. We are here to maximise value for our investors. It is a people business and so there is a huge variety of factors that make up the sort of manager that can deliver that objective. I'd also say that you need different qualities according to the type of investment a manager makes. So a European manager may require different skills and attributes from that of a US manager. The same is true between venture and buy-out. But there are some constants. It is important that the team has worked together before and has worked together well. We look for firms that have a franchise position in their particular market. If they don't dominate their market, they clearly need to have a leading edge.

‘Track record is important because it can demonstrate that, over time, firms can deliver strong returns. But we are in a changing market. We are moving to the next generation of manager and so track record is not everything. We like our investment managers to have their interests aligned with ours - just as ours are aligned with our investors. We have CHF200m of capital that we invest alongside our clients to ensure that this is the case. We like honesty and integrity. Selecting a private equity fund manager is in many ways no different to investing in a public company. You want strong management, excellent teamwork, a strong position in the market and the ability to deliver.'

What puts you off an investment?
‘There are many reasons for funds to be eliminated during our investment process. The first reason would be for asset allocation reasons. The rest would be poor performance, track record, the size of the team and their relative position to their sector of the market. But there can equally be deal killers on the structuring side.'

What is the biggest mistake that you have ever made?
‘I think that our biggest mistake has probably been not having reacted aggressively enough when we have noticed that a fund has drifted from its investment area or there has been a change in the implementation of a strategy by a private equity firm. It's important when you see that something is going wrong that you react incisively. Your best - and probably only - course of action is to sell. If you react after the event when the bad news is already out, then it's very difficult to sell. What we have learned over the years is that the due diligence process is only a part of what we do. We have to manage a portfolio actively, we have to be close to the investment managers. If there are things that you are uncomfortable with or you are seeing things that you didn't buy, you have to take a radical decision. We are here to maximise the value of our investors' portfolios; we are not here to perpetuate portfolios that we manage.'

What irritates you about the private equity market?
‘What frustrates me is the lack of consistency and clarity in the valuation and reporting processes of private equity firms. That is critical in a market as volatile as the one we are in today.'

What is the biggest issue in the market?
‘I don't think that the key issues in the market are specific to private equity. They are beyond firms' control. They are: the state of the stock markets and the state of the economy. Not so long ago, many people in our asset class were saying that private equity was not correlated with public markets. We have seen that there is, in fact, a strong correlation, but with a time lag. Whether you are in venture or buy-out, you need the public markets. It has been very sad to see the collapse of the new stock markets because their arrival was a good thing for private equity. Exits and value are now becoming more difficult. That is at the forefront of many buy-out managers' minds today. They will have planned exits that they haven't been able to make and time is money.

‘The other issue is the general economy. Private equity is founded on the principle of investing in growing companies. It's not down-sizing companies or asset-stripping. So it becomes much harder when we're teetering on the edge of a recession.

How do you think that the market will change in the future?
‘On the investor side, many institutions are still coming to terms with the losses they have incurred on their public equities portfolios. So they're not thinking too much about private equity. But over the longer term, this will change. It will be driven partly by the move to active from passive portfolio management. Some of the most active forms of investment are hedge funds and private equity. I would expect institutional allocation to private equity to increase over the coming years, certainly in Europe.

‘On the GP side, we will inevitably see change coming from the new generation of fund managers. There will be new firms springing up and new strategies will be developed. That's very healthy. Private equity managers like to impose change on the companies that they manage, so I think we should expect change in our own industry. Some private equity firms have become too institutionalised and yet they try to practise entrepreneurship. These are contradictory forces and firms will have to deal with that.

‘Another point of change - and I'm not sure how significant it will be - is the role of hedge funds and their potential interest in private equity. Hedge fund managers have a different appreciation of risk to private equity managers. Private equity managers take a long-term view and they have to be optimists. Hedge fund managers have a different view and it will be interesting to see what they will bring to the private equity mix. The biggest challenge for a hedge fund manager will be to change from having a view that goes out three months to a view that goes out six years.'

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