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Institutional investor profile: Tim Jones, investment director, Coller Capital

Tim Jones on Coller's recent Lucent deal and why that is unlikely to be the last of its kind, on chasing financial tornadoes and on why he thinks that secondaries deal flow is about to explode.

Set up in 1990, Coller Capital is one of the more established secondaries players on the market and currently has $1bn under management. The firm hit the headlines earlier this year after it acquired 80 per cent of Lucent's corporate venturing portfolio.

What type of investments do you look for?
‘We are focused entirely on secondaries. That's all we do. By secondaries, we mean a number of different types of transaction. One of these is the acquisition from the original investor of its investment in a limited partnership before its maturity. Another is the acquisition from a general partner of the assets in a fund before the maturity or exit of those assets. It is also, as in the case of our recent Lucent deal, the acquisition of a portfolio of direct investments. An interesting part of our strategy has been to do portfolios of direct investments as well as limited partnerships. The key thing is, though, that they all go into one fund.

‘We tend to look at more mature assets than is usual within the secondaries market. This gives us greater visibility and exposure to the underlying assets, allowing us to analyse their cash flows. We can predict more accurately when the exit time will be on each of those assets. The real benefit of this strategy for investors is that we can return cash to them much more quickly because of the maturity of the assets.'

How do you find out about good secondaries prospects?
‘We have the largest investment team internationally, consisting of 15 professionals. The more people you have, the more deal flow you will hear about. We have also deliberately built up a team that is like a mini United Nations - it is truly multinational. If, for example, you're buying from a French investor, you have a powerful competitive advantage in hearing about the deal and more importantly in closing a deal if you have a French investment director who has a deep pool of relationships and understands the language and business culture.

‘We hear about a lot of deals around the world both through our own network and from referrals. Clearly, Coller has a good name, franchise and reputation in this market. We get an awful lot of referrals coming in to us directly from the seller and from intermediaries.

‘People talk about proprietary transactions, but I'd say that you tend to get a lot of chit-chat and what is more key is turning that chit-chat into a deal. One of the things that we have demonstrated time and time again is that we can turn something that you hear about into a proprietary transaction. That comes from our ability to move fast, to execute and to close.'

There haven't been many auctions in the secondaries market to date. Do you think there will be more in the future?
‘Everyone thinks that auctions will be a greater feature of the secondaries market. But to do a proper auction, run by an investment bank, the portfolio has to be a certain size otherwise the investment bank won't get involved. Besides, there are only a few investment banks that have experience of running auctions. There are probably only about three or four that can be absorbed in the market or be run by investment banks in a year.

‘Auctions are probably appropriate for some of the bigger sellers because they want a lot of transparency because of their duty to their trustee board, for example. But it's very difficult to execute them efficiently. People will try to do auctions and they may succeed or not, but they will probably go back towards having more negotiated transactions in which they invite one or two professional investors in to look at the portfolio.'

How important are the skill sets and expertise of general partners when you're looking at a secondaries portfolio?
‘We used to think that they were irrelevant. But that is clearly not true. When you buy an interest in a fund, the fund will typically be fully invested. We analyse the underlying assets to value them. The general partner can affect their value and exit timing. So we think that a GP can add or take away about 20 to 25 per cent of the value of a portfolio. A good GP will enhance the value of the exits; a poor general partner will not. That's the type of range that we tend to look at.

‘As part of our analysis, we look at how good the general partner has been in value creation and exit timing. Another critical part is looking at the incentives to ensure that the carry and management fee incentivise the general partners to perform on behalf of the investors.'

What do you think makes a good general partner?
‘We look for a proven track record and a stable team. We prefer older teams because we can see their track record in terms of exits and value creation. But we also want teams that are still motivated to drive for exits. We like to take capital off the table relatively fast, so we look for GPs that have been good at generating cash distributions back to investors quickly.

And, in this tough economic environment, it's important for general partners to have good operational experience. They can add more value at the moment to a fund than financial engineers. The exit environment is tough right now and so GPs need to be able to add value to companies by increasing operational efficiency rather than being creative by using bank debt and gearing. This type of factor changes according to the economic environment.'

How do you put together a new portfolio?
‘This is an opportunistic business. So we will look at the portfolios that the sellers bring to us. Those portfolios may have a mix of Europe and US - we don't like emerging markets - and buy-out and venture. Sellers tend to want to sell the whole portfolio, rather than allow you to cherry-pick. There is some cherry-picking happening at the moment, but that is unusual. If you don't like an asset or a fund within a portfolio for sale, then you price it accordingly. As a fund manager, we don't have asset allocation targets, we are opportunistic and our pricing reflects the mix that we currently have within the fund and the mix that we want to create.

‘Take our last fund as an example. Before the Lucent transaction, it was largely buy-out and largely old economy. We had very little technology exposure. We bought NatWest's pre-1996 portfolio, which was made up of old economy companies and we bought that at a time when no-one liked old economy companies. Having done that, we were quite keen to be contrarian on the technology side. So we were looking for technology when everyone else hated the sector. The Lucent portfolio provided a good balance with the NatWest portfolio. So we had technology venture and old economy buy-out. We do look for balance in our funds, but opportunistically.

‘One of the good things about secondaries is that you naturally tend to end up being diversified all the way through to the investee company by industry.'

What are the most interesting developments in the secondaries market?
‘It will be interesting to see whether there will be any more corporate venturing portfolios dislodged. We have looked at a few and the Lucent portfolio was very attractive to us because of its high quality and the partnership relationship with Lucent. There will be more coming into the market because if you look at exits in this climate, together with the fact that companies are focusing on their core businesses, how else do they exit?

‘I think that we may find general partners looking to exit from their investments in their more mature funds through secondary sales to secondary investors. How else do you exit your tail-end assets when the IPO and trade sale markets have slowed down? We have done some of this type of deal and I can see that being a trend.

‘Otherwise, I think that there will be a huge explosion of deal flow from all angles. There are large numbers of limited partnership interests for sale, and these are the bread and butter of the secondaries market. Clearly, a lot of that is the 1999 and 2000 bubble, where people who were new to private equity got their fingers burnt in the dot.com euphoria and are now looking to exit unfunded commitments. But there is also a good, increasing flow from high quality assets, too.

‘This has been driven by two things. One is that, if you look at the amount of money raised over the last decade that drives a need for liquidity. If you look at the junk bond bank debt markets, you needed to have an invested pool of capital before you needed a secondary market. The same is true with private equity and I think that we now have that.

‘The other point relates to the economic climate. Most of the world is in some form of recession. That has meant that underlying investors - companies, pension funds, banks, insurance companies, whatever - have issues with their mandates because the fall of public markets has thrown their portfolios out of balance or they are looking to their core businesses, at their capital adequacy ratios, cost of capital and core cash flows. They want to gain liquidity from their illiquid assets. The investments that they have made in the past may no longer be core to their strategy. The company may be downsizing so it no longer has the ability to be in illiquid assets and need to free those up.

‘We have seen some very nice assets coming onto the market. What has changed over the last three months or so is that sellers' expectations have reached more realistic levels as to what those assets are really worth. If you go back nine months, there were a lot of people looking to sell. But it also takes a while for a general partner to revalue his assets. There is a lag after the market falls. Therefore, the sellers' expectations are unrealistic as to what those assets are worth. As an investor we have been very wary of falling valuations and we haven't wanted to be catching falling knives. Over the last few months, GPs have marked their portfolios down in general, so sellers have become more realistic while at the same time becoming more motivated in their desire to sell. Their expectations are more in line with what we would expect to pay. That's quite a big move.'

So what happens when the market picks up again?
‘I don't think that the market will pick up that much for quite some time because, while recessions have traditionally been over a period of 12 to 14 months, we don't believe in the hockey stick recovery, in which the economy shoots back into full flow again straight away. So we'll be in recession for a couple of years at least and that will continue to supply us with deal flow.

‘If you look back over the last decade, the US has had an uninterrupted bull run. Europe hasn't and Japan certainly hasn't. And just because the US suddenly kick starts back into action in a couple of years' time doesn't mean that the rest of the world will. So the chances are that there will be something going on around the world that will create deal flow for us. We chase financial tornadoes to provide liquidity.'

How do you conduct your due diligence?
‘It's very extensive in a secondaries transaction because you have to look at every asset in each fund and do your own valuation - you ignore the general partner's valuation. You need to have a large team to be able to do this. Speed of response is paramount. We also have one of the largest databases on private companies, so that helps, but you still have to do exhaustive due diligence and analysis of the portfolios and the investee companies. And we would go through exactly the same process with each prospective investment, irrespective of whether we are already invested in a particular fund or not.'

What advice would you give to an investor who is new to private equity?
‘I'd say that this is a good time to invest. First of all, I'd invest in secondaries. I would say that, wouldn't I? But there is a very good underlying reason for it. Typically, a new investor would be advised to invest in a fund of funds to diversify risk and to get to know the underlying fund managers. The disadvantage of that is that, in this environment it may take a long time to get your cash invested because the underlying funds are investing very slowly at the moment. You would also go through the J-curve - it will take a long time to invest the capital and it will be even longer before you get your capital back.

‘If you invest in secondaries, you still have the same effect of going into a fund of funds but they are backdated funds and the capital goes out faster and you get your capital back faster. You enter the private equity universe and get to know some of your underlying funds through your secondary investor in a more efficient manner.

‘It's a very good time to invest. Multiples have come down. If you invest in the primary market, you have to be extremely careful about who you invest with. It's like going back to the early nineties - we loved buying positions in early nineties funds because the underlying investments were made at low multiples.'

What is the main issue for the private equity industry?
‘There are funds that started off in life in the late nineties that have maybe had one fund. Will they be in business for much longer and will they ever hit carry? Will they be in the market again? For some general partners that invested fully in the late nineties, it's unlikely that they will ever hit carry. If that's the case, what does that mean for investors? GPs will not be incentivised. Clearly, the ones that have been around for some time will struggle through this and come out the other side. But it's a real challenge for the newer funds. So I think we'll definitely see a shrinkage.

‘Exits are an issue for many funds. How are they going to do it? And how will they create value in the underlying companies?'

How do you think that the private equity market will change?
‘We will go into a period of slowdown as the market corrects. Are we going to have a decade like the nineties? Not for some time, I suspect. It was easy to make money in the nineties. If you were a buy-out fund, you bought at a multiple of four times and sold at six times. It wasn't that difficult. I think funds are going to have to work much, much harder to create value and make money in the future.

‘But private equity as an asset class will continue to grow. If you look at the returns in the public markets, they are unlikely to be great - in the region of around six per cent - and if you look at the bond markets or the debt markets, returns won't be great there, either. Pension funds and other institutions are going to have to enhance their returns somehow. They have to create value over and above what the public markets can return to them, so they will have to invest in alternatives. You will continue to see money flowing into private equity and private equity will continue to develop as a true asset class.

‘You will see more attempts by bankers to create products such as securitisations of private equity fund investments. How successful will they be? I think the jury is still out. But I think you'll see more attempts by investment bankers to create more value around the private equity universe.'