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Institutional investor profile: John Porter, Hamburgische Landesbank

Porter on the current state of the German private equity market, on securitisation and other ways of attracting new investors to the asset class and on the importance of bottom-up selection.

Hamburgische Landesbank started investing in private equity in 2000 with a budget of E500m from the bank's balance sheet to commit over five years. It has committed in around 20 funds to date. With a private equity team of six currently, the bank intends to build up its private equity investment capabilities with a view expanding its investor base in the future.

What type of investments do you look for?
‘We commit to funds in a variety of ways, like most investors. We do a combination of top-down portfolio planning and then a bottom-up selection of the best investment teams that we reckon to invest in. We tend to put much more emphasis on the bottom-up approach. There is no point in sticking rigidly to a strategy defined by a top-down approach if you can't find the right funds to invest in. We don't believe that we should be using our portfolio model to dictate exactly where we invest. You need to be flexible enough to take advantage of opportunities as they come up and be conscious of the fact that only a certain amount of funds will be raising at any one point in time.

‘We invest in Western Europe, including Scandinavia, but we have an open mind about Central and Eastern Europe. We will certainly look for potential investments there when the accession countries join the European Union and when we feel that there are experienced teams with investment acumen based there. Despite the fact that we are based in Germany we don't have a particular mandate to invest here over other European markets.

‘We have a preference for buy-out funds - they make up around three-quarters of our portfolio as it stands at the moment. Venture makes up the rest - so far. This is likely to change as we commit more of ou2 money. We would like to invest in mezzanine in the future, although we haven't done so as yet.

‘We are also able to allocate up to 20 per cent to co-investments, but we haven't committed any capital to these yet. We have seen a lot of “opportunities”, but we are still working on the deal flow to ensure that we are looking at the best investment prospects. There was a lot of movement in the market last year, with valuations moving southwards and so we weren't keen to invest directly in companies in that type of environment. We want to see the quality of deal flow improve before we start co-investing. It is an important part of our strategy, but we are more attached to the quality of the project and of the investment than we are in sticking to rigid allocations.'

Why are you more focused on buy-outs than venture?
‘We reckon that Europe is much stronger in buy-out than venture. There are some very good venture teams here, but if you wanted to weight your portfolio more heavily towards venture, then you would have to invest a lot more in the US. We don't have the resources to do justice to the US market as yet. And anyway, there are plenty of interesting opportunities in Europe to keep us busy.'

Where are you seeing the most exciting opportunities in Europe?
‘Obviously, the French and UK markets have the greatest depth and breadth of experience and track records. But there are exciting opportunities in Germany. I know that people have been expecting great things from Germany for so many years now that they have pretty much stopped talking about it, but it is still under-served by private equity and there are plenty of companies that are right for private equity investing, so I think there is promise and value to be generated there. I think that Germany has the potential to expand more rapidly than say, the less developed markets of Spain and Italy, if the necessary shift towards entrepreneurialism does actually take place.

How are the recent tax reforms in Germany affecting deal flow?
‘The tax reforms will start to loosen up some of the deals. We haven't yet seen much evidence of this, but it's only been just over a month since most of the changes came into effect. There is anecdotal evidence to suggest that some of the larger investors, such as Allianz and some of the re-insurers, have started shifting around some of their shareholdings in the background with a view to selling packets of share to financial investors. Some of these are so enormous that they are beyond the reach of private equity buyers but some may be of interest.

‘We haven't quite seen a tide of deals and we're not getting euphoric reports from general partners that they have had a huge influx of deal flow since 1 January 2002. I think it would have been unrealistic to expect that.'

Would you invest in a first-time fund?
‘That depends on the definition of a first-time fund. We wouldn't be interested in investing a group of consultants or bankers, for example, who suddenly decided that they would like to try their hand a private equity investing. We wouldn't invest in people who haven't had experience in the industry. But we would invest in spin-outs from institutional banks, for example, or in teams that have left a large buy-out firm to set up their own fund. We certainly wouldn't exclude this type of GP on principle, but the track record has to be there, the experience has to be there and there has to be something there that tells us they're worth backing.'

What do you look for in a private equity fund manager?
‘We are in this to provide the best returns possible for our investor - the bank that has supplied us with our capital. Our ultimate aim is to look at the capability of a fund to do that for us. There is soft element in this that we have to judge - it's the investment nous, a nose for a good deal and being able to sense out value. But obviously, there are the harder elements that we have to look at - the deal sourcing, deal-doing skills, knowledge specific to particular industries and countries. What we're really assessing when we look at a fund is that the team's skills are developed and that they will be applied over the lifetime of the fund. Some firms are also setting up strategy teams to help their portfolio companies and we'd look very favourably on groups that do this kind of thing.'

How do you assess these qualities and processes?
‘We have the standard due diligence processes, we have questionnaires to fill out, we go through documentation provided by the general partners, we will recalculate IRRs so we do quantitative analysis. But above all, we spend time with the team. We try to understand their motivations for doing what they are doing, we talk about deals that they have done, about the way that they have generated value. It's really down to understanding the managers' mentality and ensuring that they have high levels of drive and energy - you need that in private equity. So the quantitative analysis is vital, but then so is getting to know the people that we invest our money with.'

What advice would you give to a new private equity investor?
‘We are relatively new, so I would advise other new investors to go through the same processes we did. Decide how much you want to invest, which needs to be a reflection of how much you can have tied up in private equity and of assumptions on when you would need to see returns. This will probably help you decide whether you should have as your strategy investing directly in funds or investing via a fund of funds. Some of the self-serving arguments that the funds of funds make, such as early diversification and in-depth knowledge of the industry, do actually make sense to new investors. We certainly saw an element of value in them and we used funds of funds to start with to get rapid diversification and to cover areas of the market that we couldn't invest in ourselves. That can make sense for some people. Some investors may even want to invest their whole allocation in funds of funds, especially if they do not have a large sum of capital to commit or the resources to manage direct investments in private equity funds.

‘If you do decide to invest in funds directly, then be aware that you really do need resources to manage the portfolio appropriately. You need people to devote their full time to doing this - it's incredibly time-intensive.

‘The other thing I'd say is buy some decent software to keep track of all the investments that you've made and the reports that GPs send back to you.'

What is the biggest mistake you've ever made?
‘Well, as relatively new investors, it's hard to judge that. In this industry, mistakes take a long time to materialise.'

What is the biggest issue for the private equity industry?
‘Securitisation seems to be taking off. That's indicative of the way that people are looking at packaging private equity investing in different ways to attract more investors to the asset class. There is a lot of talk at the moment about how much institutional investors in the Continent will increase their allocations to private equity. Will they allocate as much as their US counterparts, for example? A lot of people are expecting typical allocations to increase from one per cent up to four per cent.

‘The model of private equity has, to a certain extent, proved itself. The volumes of inflow and outflow that you have at the moment suggest that private equity has become firmly established in Europe. Our own research and the reports that you see all point to the fact that insurance companies and pension funds are intending to invest more in private equity and so I can see it becoming a more mainstream alternative asset class.

‘The problem in Europe is that there are all sorts of legislative barriers to many investors and the private equity industry is having to be quite inventive to get around those barriers or to exploit loopholes. It would be far better if those legislative barriers were removed, especially at a local level. But I think you will find that securitisation and other less traditional forms of private equity investing, such as listed vehicles, will have a role to play in encouraging more investors to the asset class.'

Do you think that there are enough opportunities out there to support this increase in institutional money?
‘That's the other half of the equation. We saw a massive rise in the amounts raised by firms in 1999 and 2000, which has now slowed. But the signs are that over the longer term that continental institutions are interested in contributing more to private equity. The big question is whether there are enough good teams to put that money to work. I would say that over time, there will be more experienced people in the industry and they will get better at it. Some of the structures in place at firms on the Continent may not match exactly those used by the US or the UK, but they are not completely useless training grounds. There are increasing numbers of people in Europe who have the type of investment experience that is needed to help the industry become more mature and professional. You're already starting to see spin-outs from larger funds and that is one of the signs that the industry is evolving and developing.

‘There will be a larger number of talented and experienced investment individuals in Europe over the mid-term. These are people who have chosen to get private equity experience and have had the opportunity that didn't necessarily exist before to hone their skills.'

How do you think that the market is likely to change over the future?
‘We are constitutionally optimistic about it. We think that it will grow and that it will become a more important source of finance for Europe's most promising companies. That will be the driver of the industry's growth. And, further upstream, different ways of providing that equity capital will be developed.

‘As for particular areas of promise, I think it's difficult to predict. This market, possibly more so than most others, is opportunistic in nature. Even in private equity, which is a long-term business, sentiments and fashions change. People have to adapt to those changes using their better judgment. The type of investors that we look for are ones that will generate opportunities by doing things differently and seeing value in areas that others have overlooked or neglected.'