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Institutional investor profile: Peter Schwanitz, Managing Director/Geschäftsführer , Oppenheim Private Equity Manager

Schwanitz on the consolidation of the fund of funds market, on the value of honesty, on why management fees should be lowered, on the disappointment that is the German market and on learning from your mistakes.

Oppenheim Private Equity Manager is the fund of funds arm of private bank Sal Oppenheim, which has a long history of direct investments and began investing  in private equity funds in 1998. With commitments from private clients and several small and medium-sized German institutions, Oppenheim Private Equity was established in 2001. Based in Cologne, Germany, it has one fund so far that is expected to close before the end of the year at E60m. It invests in Europe and the US in buy-out and venture capital funds as well as some secondaries positions. It has a joint venture set up with Portfolio Advisors, based in the US. Schwanitz has been at Oppenheim since 2001 and before that, had worked on the private equity portfolio and fund of funds operation at AXA Colonia since 1995.

What type of investments do you look for?
‘We have set out to offer a standard product for our clients. That means that our focus is on the regions in which private equity is the most advanced. So, in principle, we have a target allocation of 60 per cent to the US and 40 per cent to Europe. By investment style, we have allocated one-third to venture capital and two-thirds to buy-outs and special situations.

‘But in practice, we have ended up revising our allocations slightly because of our concerns about European venture capital. As a result, in Europe we will probably have between 80 and 85 per cent invested in buy-outs and special situations and the rest in venture capital, while in the US, we will stick to our one-third/two-thirds allocation.

‘We are also very interested in investing in secondary positions, although not in secondary funds. We believe that by investing in secondaries, we will be able to get a better vintage year diversification in our fund of funds. We are seeing a lot of interesting opportunities in this area and we are looking primarily at buy-out secondary investments.

‘We have the capability to do co-investments, but given the relatively small size of our first fund of funds, we are unlikely to make any this time around.'

What size investments do you tend to make?
‘The typical size of fund commitments ranges from E3m to E5m. Clearly, this is one of the advantages of working with Portfolio Advisors because we can invest alongside them and they can invest alongside us. This means that together, we are able to exceed the minimum investment level required by many general partners.'

How does your relationship with Portfolio Advisors work?
‘We are working together as a joint venture. We co-operate on pre-selection and due diligence: Portfolio Advisors sources investment prospects in the US and we source them in Europe. As soon as we have mutually decided to pursue an investment opportunity and to go into due diligence, we work very closely together. We visit firms together and we all do reference checks. It's a combined approach.'

How do you find out about investment prospects?
‘We try to be proactive about sourcing investment opportunities. Portfolio Advisors has 1,400 funds in its database and we have built up our own database here, too. We know which funds will be coming to market and when. We have developed a forward calendar of fundraising based on the information we have about funds and that goes back five years. We record when funds have their final close, the size of those funds, which investments they have made in the past, etc. Investment pace has slowed over the last year or so, which means that we have revised our calendar a little.

‘We hear about opportunities from placement agents, too, and we also have a lot of contacts in the market. I have been in private equity for seven years, for example, and so we get a lot of information from our contacts.

How do you put together your portfolio?
‘I would describe our approach as principally top-down but using bottom-up information. We attempt to identify the most interesting areas, while also understanding the detail about individual private equity funds. So we sit down every three months with Portfolio Advisors to talk about our views on the market. That's why, for example, we have decided to reduce our allocation to European venture capital. We felt that the future for this sector was relatively unclear. We believe that there will be some consolidation in the market, but no-one knows how long this will take.'

What do you look for in a fund manager?
‘We look for managers that give us the impression that they really know what they are doing. We look for people with experience of private equity and also of the area in which they plan to focus their investment strategy. Indications are a strong track record and proven discipline in their investments. We also have to get the feeling that they are open and honest with their investors. For me, that is exceptionally important - I need to know that I will get the information I need clearly and on time.

‘We also look for the ability to learn from mistakes and to explain why something has gone wrong. The problem is that many are unwilling to talk about things that have not gone according to plan. Venture capital funds, for example, have had difficulty admitting that not every single investment they have made has been successful. I try to make them realise that it is not a problem to admit that there may be some write-offs in their portfolio. I recently had a very open discussion with a GP who was very happy that we were able to talk frankly. Many GPs aren't open with their investors because they are worried about how they may react and because success is what drives them. Many people thought that they could walk on water. They are now very disappointed that they are having to swim.'

What puts you off investing in a fund?
‘I am troubled by funds that charge higher than the standard carried interest. I'm hoping that limited partners can develop a common view on this and simply refuse to pay 30 per cent carry. I tend to look for market standard terms and if that is not what a fund is offering, it does tend to put me off. The other situation that is linked with this is that as fund sizes increase, the management fee should be reduced to avoid the situation in which general partners are able to get very rich even before they have made a single investment. Large management fees could have a negative impact on performance - and that will affect GPs and LPs alike.

‘Another thing that puts me off is feeling that a GP is not being open and honest with me. I hope that the market will develop so that the GP-LP relationship becomes one in which the communication between the two parties is open and transparent. So far, it has been a market in which people have been able to create a demand from investors who have not fully understood the characteristics of the asset class.'

What is your view about the prospects for the German market?
‘I am naturally very disappointed that the market has not developed as strongly as those in Scandinavia or even in France. I think that one of the issues is that some of the most attractive investors for mid-sized company owners are wealthy families rather than private equity firms. People who have built up their own company have a certain pride in their business and are less willing to sell up to a firm with a limited investment horizon. That means that German private equity players suffer from a lack of deal flow.

‘The other point is that Germany has been dominated by venture capital and many VC firms in the market - being relative newcomers - are now fighting to survive. Success isn't even an issue here; it's a matter of survival. There are some interesting pockets of venture capital in Germany, such as that focused on life sciences, but the technology and telecoms firms are struggling. The established groups, such as TVM, Atlas, etc, have a very strong position in the German market and they will do well. Many of the others are likely to disappear.

‘On the investors' side there are the insurance companies in Germany. They have been going through a difficult time. But they will recover, and when they do I think that they will reconsider their allocations to private equity. So, instead of them all having broad allocations of, say one or two per cent in private equity, you will see a differentiation. Some investors will decide to start serious private equity programmes. There, allocations will increase to up to five per cent. On the other hand, a lot of players will withdraw from private equity investing. That can only be positive because then we will have a stable and dedicated investor base here in Germany. That will help create a good, strong market here in Germany made up of domestic-focused private equity teams. But, given the ongoing tax discussions here, as long as the experts advise that it's probably better to run a fund from outside Germany, this development will be delayed.'

What irritates you about private equity?
‘The market has grown very quickly - probably too quickly - and people have lost their focus on the fundamentals of private equity, which are, I believe,  doing adequately priced transactions, having the ability to change and turn around businesses and creating value. I find that irritating, but I think that some of that focus is beginning to return to the market now that the period of excess is over.'

What is the biggest mistake that you have ever made?
‘I think that my biggest mistake - and I was far from being alone here - was starting to believe in the investment opportunities in the internet space. That was a very valuable lesson for me. I now know that I should always develop my own ideas about opportunities and stick to them. That is particularly important in private equity.'

What is the biggest issue in the industry?
‘One of the biggest issues is ensuring that investors understand that private equity is for the long term. This means that GPs need to manage the expectations of their limited partners effectively. To do that, they need to build up a relationship based on trust. This issue is crucial here in Germany, where investors are still relatively new to private equity. I think many are still perplexed by the J-curve effect and there is a danger that many will be put off by the negative returns in the early years. People have to understand the characteristics of private equity before there is a stable, ongoing interest among investors. I believe that a lot of people over-estimate the appetite of investors for private equity. There is a huge knowledge gap between GPs and LPs and that is one of private equity's most crucial issues.'

How do you think that the market will change?
‘Sitting here in Germany, I think that one of the changes here will be a shift in focus. Investors here have been very focused on venture capital, but as they develop a better understanding of private equity, I think that they will start investing more in buy-outs. I also think that GPs will start looking a lot more closely at mid-cap companies again. Many firms that started in this area have moved into the large buy-out arena - some of these may start looking again at smaller deals. There are a lot of opportunities there.

‘Europe will also see the emergence of distressed and special situation funds as we already see in the US. There are already a few focusing on turnarounds, but most do not have an appropriate track record and their emphasis is very much on turnarounds rather than distressed assets.

‘In the US, I think we'll start to see a much more stable economy. Allocations from institutions could well go down as investors attempt to rebalance their overall portfolios and as some of the opportunities start to dry up. It will be much harder to generate stellar returns in buy-out funds. This is partly because of the credit crunch and partly because corporate restructuring has already taken place to a large extent. So I am more optimistic about the prospects for European buy-outs than I am for US buy-outs.

‘I think the fund of funds market will change, too. I think that the fees charged will come down now that it has become so much more competitive. We will also see pretty wide-scale consolidation among funds of funds. It may not be very rapid, but I think that those who have been successful in the last few years will take advantage of this and build up their size. The critical issue is whether they will be able to continue delivering good returns - we're talking here about the years 2008 or 2010. For the others, I think there is room for co-operation and potentially mergers. But there are also some that are only just able to pay their general partners - they are likely to disappear from the market.'

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