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Institutional investor profile: Sandra Robertson, head of alternative assets, Wellcome Trust

Robertson on why some venture capitalists earn their fees and carry and others don't, on the current capital overhang and on the transparency debate and where it's heading.

Formed in 1936, the Wellcome Trust has a remit of funding medical research for the betterment of mankind and is the largest medical research charity in the world today. The Trust has a diversified investment asset base of around £12.5bn split into public equity, alternative assets and property. It has over E3.5bn committed to private equity.

Why did the trust decide to invest in private equity?
‘Unlike a pension fund, the Trust has an infinite lifetime. Naturally, therefore, we can take a very long-term view. We believe that over the long term, equities will outperform other asset classes (we include property and alternative assets in the generic sense of equities). We are also quite different from other charitable foundations in the UK in that we can be more flexible about where we invest our money. For that reason, we have looked to the US for examples of best practice among foundations and endowments and they have been great supporters of private equity for many years. We have a long investment time horizon and we also have a very sophisticated investment committee. It was seen as very much a natural step to start investing in private equity.'

What type of investments do you look for?
‘We have focused most of our investment in the US. If you were to invest by market cap on any sort of index, then you would naturally invest in the US because that's where the market is. About 70 to 80 per cent of our private equity activity is in the US. The rest is in Europe, with a small amount committed to “the rest of the world”. We have very small interests in Latin America, the Far East and even Russia - we are long-term investors, after all.

‘Our alternative assets area has several portfolios. The largest is private equity, which includes venture capital and distressed and all the range of private equity strategies. We have a very small direct investment portfolio and we have what we call a specialist portfolio, which is for strategies that don't necessarily fit in the other portfolios. We also have a hedge fund portfolio. Within the private equity portfolio, we have three relationships with fund of funds and that probably forms less than five per cent of the whole portfolio. The rest is invested directly into funds.

‘I should add that we in the investment division have a financial return objective so we do not have an automatic bias towards investing in any particular sector.'

How do you tend to build your portfolios?
‘We have taken a measured and balanced approach. We like to diversify by geography, vintage year and stage of investment. If you decide to commit large amounts to one asset class then you're really at the mercy of what comes to market at that time. We have a very flexible approach. We work towards the balances that we want between different strategies or regions and we're very mindful of it when we're adding new groups or not making follow-on commitments to groups we already invest in. If we see no opportunities this year, we are not obliged to make new commitments.'

How do you find out about investments?
‘We use advisers in the US but we also tend to find out about things through the market. People know the Wellcome Trust, particularly in the US, so we are approached by the GPs themselves. But we also talk to other LPs and placement agents and we'll hear opportunities through the grapevine, such as via GPs who have friends or contacts who are raising funds. It's very rare that we will read about a fund in a newspaper that we haven't heard of. It tends to come in to us or we'll find it on our travels when we're out and about.

‘We know who we want to invest in and we're also very active in going out to find the type of funds that we want to invest in. You will find Wellcome Trust in funds that other people are not in. For example, we are in a Swedish fund that has no other foreign limited partners. We are very proactive, but people do tend to find us as well. I would say, though, that it's very hard to find the good groups in Europe. You really have to go out and find them because the market isn't so efficient for fund-raising.'

What do you tend to look for in a private equity manager?
‘Depending on our strategy, we're looking for different things. But there are a few things that we like across the board, such as independent groups as opposed to captives, we like people who have had both operational and financial experience and we like people who have been in industry or in this business for a considerable amount of time.

‘We will back first-time funds, but we do not back first-time investors. You need experience to be successful in private equity, despite what happened over the last few years. There is absolutely no doubt that there was a lot of money raised by some very inexperienced people in 1999 and 2000. Many of them may have thought that it was an easy way to make money. But venture capital is hard work. There is a reason why institutions like us pay two per cent management fee and 20 per cent carry. It's not easy. And it shouldn't be easy.'

Where do you think the main opportunities are?
‘On the venture side - I know it has had a bad press - but there are some very interesting groups in Europe. These are groups with experienced venture capital investors, they have been funded only by institutional investors in their domestic market. They have a track record, they've made mistakes, they've had exits and they are well below the radar of the normal money-raising machinery. We really like those groups. They own their management company and they are putting their own money on the line. It takes a long time to find them and it is difficult even when you do find them because you generally have to help them introduce more institutional-type terms but they are generally very receptive.'

What is the biggest issue for the private equity industry?
‘I don't see this as a single industry. There is a big difference between buy-outs and venture capital. But if there was one issue that affected both areas, then it would the vast overhang of capital that is in the market. This means that there are a lot of people who are obliged to invest that capital. If they are obliged to invest it, where are they going to put it to work? That worries me. Some people will give the money back - we've already seen that happen. One fund we know of has released its LPs from all their commitments; another has cut a percentage of the commitments.

'In different sectors, you will find different things happening. In life sciences, for example, there is money pouring in. I'm very nervous about that. It's not a part of the industry that people looking for short-term gains should really be in. Inevitably, it pushes up prices and there are a lot of very expensive deals being done in life sciences right now, especially in Europe.'

What is the biggest issue for limited partners?
‘There is a great move to have transparent and efficient markets in the same way you would in the public markets. Private equity doesn't lend itself to that level of transparency. But there are some areas where LPs can make progress. One of these is financial statements. There has to be more transparency in financial statements and they need to be more user-friendly. The US funds tend to be a lot better in timeliness and clarity in their statements than their European counterparts. However, several of our European funds have offered to come in and talk to us about what we would like, so that is a step in the right direction.

‘Other issues are to do with the amount of capital going into the market. Venture capital does not lend itself to large sums of capital. Investors who want to commit and have floor limits are going to find it very difficult to invest in venture capital. You will also find that in venture capital, particularly in the US, the very best groups are closed. If people are basing their decision about whether or not to invest in venture capital on the returns we have seen to date, they are likely to be disappointed. They won't get access to the venture funds that made those returns. That's an issue on the venture side.

‘On the buy-out side, you're seeing increasingly large funds. There is a worry there about motivation. Are funds simply relying on their large management fees or are they actually still motivated by the carried interest? It's a big issue. Unfortunately, with this asset class, you can back a group that you really believe in who, in the next fund, raise four times as much as they did in their previous fund. When they are earning two per cent on E4bn, that's a lot of money. You can get rich without getting up in the morning. People need to choose very carefully and they need be very clear about what return objectives they have. They shouldn't necessarily assume that the risk-reward profile is what it was before.'

Do you think this is an issue that limited partners can do much about?
‘Some LPs negotiate legal documents, some don't and others negotiate special deals. Those with capital that are looking to invest large tranches in large funds at the moment are finding that GPs are more open to cutting special deals. That doesn't necessarily benefit the other LPs in the fund.

‘There are a lot of very large institutions that have decided to allocate money to the asset class. If they have a remit to invest a significant amount in a year, they may have to compromise on quality to ensure that the total is committed. It also allows them to negotiate special deals because they have such large amounts of capital to invest. Limited partners are not one on this issue. I think that we would all agree that the fees and motivation are areas to be concerned about.'

What advice would you give to a new investor?
‘Really understand your reasons for going into private equity. Thoroughly understand what it is you're buying, whether you are investing in a fund of funds group or in a fund directly, most importantly find a good advisor.

'In the UK, several pension funds are considering investing in private equity and their natural route would be to outsource the management of the portfolio and seek advice from their traditional investment advisers. Many of the investment consultants who are being asked to take on private equity work don't necessarily have the experience to do so. They have not actually invested in the industry, they have not had to negotiate terms and had to go through the underlying portfolios and make assumptions about exits. They haven't been at the coal face. It's not the type of industry that you can simply look at a group's returns and make assumptions about the future or where success is dependent on a process, which is where research is focused.

What has been your biggest mistake?
‘Getting into the Far East too early. But then that comes down to having a balanced portfolio and having risk control. We would never put a substantial amount of our portfolio in the Far East. But there are one or two investments from which we have had some capital returned, but we're not going to make money on them. That's pre-1997.'

How do you see the buy-out and venture capital markets changing?
‘European venture capital will continue to develop. It will have bumpy patches, but then so does every industry. I think that as long as people have realistic expectations about returns, it will be a good place to invest for people who have a long-term time horizon. In the US, some venture capital groups will have some generational issues –some groups will successfully manage succession; others will naturally come to an end as general partners go their own way and spin out to set up their own firms. That's not a bad thing. That type of change is healthy in any industry. You will also see many people who didn't realise how hard it was get out of the business.

‘Buy-outs also have those issues. However, at some levels, capital is a commodity; they have to differentiate themselves in the market. Those with franchise names will continue to be successful, but they will have to work hard to achieve the types of returns we have seen to date. I think that naturally, as we have seen in the past, groups of GPs, particularly the younger partners, will go their own way and form their own groups.

‘Buy-out funds have got bigger. What else can I say?'

Do you think that will increase the focus on the mid-market?
‘What is the middle market? The mid-market space is very competitive in the UK. You always have to think of exits. People are very good at putting money into these deals, getting out is a different matter. The middle market always seems to suffer. In the previous bull market, everyone was interested in technology - in the kind of market we have at the moment, it suffers because there is not enough attention paid to the sectors you find mid-market companies in. In this area more than any other, groups really have to differentiate themselves, have a very clear strategy and stick to it.'