PRINT THIS PAGE

Institutional investor profile: Bernd Kreuter, director private equity, Feri Alternative Assets

Kreuter on developing an objective basis for private equity investing, on the emergence of new firms, on the lack of activity in the German market and on creating transparency.

Founded in 1988 as a research house, Feri offers asset allocation and investment services to high net worth individuals and institutional investors. Feri Alternative Assets provides customised solutions in the areas of private equity and hedge funds. Feri's total assets under management are confidential, but its investments into alternative assets amount to a few hundred million euros over recent years.

What type of investments do you look for?
‘We start with an asset allocation viewpoint. So we have four areas that we cover: Western European venture capital and buy-outs, and US venture capital and buy-outs. We have a balanced approach, according to segment and according to geography, allocating about the same amounts to each of the four areas. With that we try to mimic the overall private equity market even though the US market is of course larger in size than the European market.

‘We look for the best groups operating in each of those segments. It's helpful to have these categories so that we can compare groups. We tend to do our due diligence on a couple of groups within the same segment at the same time, so it is easier to compare them and pick the best managers.

‘We manage a couple of funds of funds - most of them are for institutional investors who are new to the private equity asset class. We put together customised portfolios that fit their specific risk/return and tax needs best.

‘For our private clients we have separate funds of funds. We have a fixed allocation for our high net worth individuals and recommend that they invest between ten and 20 per cent to private equity because they usually don't have the same liquidity needs as institutional or retail investors. It depends on their age. If they are only 40 or so, we would recommend that they invest 20 per cent. If they are much older than 50, we would say they should commit around ten per cent to private equity.

‘One area that we would like to get involved with is secondaries investing. But in Germany there is no tax-efficient structure yet. We do have some ideas about how we could structure this, but I think that is some time away.'

How do you find out about good investment prospects?
‘The process is pretty standard. It involves first screening, meetings, due diligence and closing. The more unusual thing about us is that we use a rating system. Feri is known in other asset classes for its rating system and we use a similar approach in private equity.

‘Private equity is obviously very different from other, more traditional asset classes, so we have taken the existing framework that we use in other asset classes and adapted the categories to private equity investing. There are 15 categories and within that, there are 200 or so criteria (or data points) that we check against each fund. We compare the numerical data points with benchmarks. From that, we end up with ratings for each category, which reflect the risk and return profiles for a particular fund. We put more weight on the risk than the return.

‘Within the ratings, we put the greatest emphasis on the management team. We look for future returns, so we try to find predictors for future returns within the ratings. Of course, we look at the past track record, but we try to find out whether this has been achieved on a systematic basis. We look at whether a team has added value, whether it has proprietary deal flow, whether it has industry or management experience, and what the management works like as a team - that is very important for us. We also look at the incentive structure, and at whether the team is cohesive. These factors will all give us an indication of whether a team will deliver the same returns as before - or perhaps even better returns.

‘The ratings give us a very systematic and standardised approach to fund investing. It also gives us a very good tool through which we can compare different teams.'

But wouldn't you say that successful private equity investing was based on judgment calls as much as quantitative analysis?
‘Of course. Only a few of our criteria are quantitative. The rest rely on judgment - around 70 per cent of our criteria are qualitative. The idea is to make it as objective as possible, so that if two people were to look at the same funds, they would end up with the same rating.'

Would you invest in a first-time fund?
‘Not usually. And we would most of the time include in this funds that have spun out of established firms - even if they have been working together for a long time. They may have the experience, but we like to see evidence that they can source, invest and exit on their own. We would probably wait until they raised a successor fund. Nevertheless, we are looking closely at some of these funds because what we've seen so far has been pretty good.'

How do you source the funds that you look at?
‘We are one of the oldest private equity fund investors in Germany. We started over ten years ago, so we are well known in the market and funds come to us. But we are also very proactive in searching out groups. It's pretty standard stuff - we ask other groups, we go through industry publications looking for groups that we do not know already. But we have a lot of existing relationships in the market, so we get referrals that way, too. Funds we have invested with are also a valuable source for finding other interesting venture or buy-out groups.'

Where are the most interesting opportunities at the moment?
‘We rather focus on management teams rather than on country or sector-specific criteria. But I think that one of the most positive things at the moment is that the excitement of the last few years is over. It's much easier now to see what's really going on. You're seeing the dedicated teams. The ones that don't have the dedication have started to disappear. There is much less noise in the market. There was far too much distraction 18 months ago. It's easier now to spot the best teams and to differentiate between the good teams and those that don't have the best expertise or experience.

‘I am seeing some developments on a regional basis, though. We are very interested in Continental Europe at the moment. The French market is really taking off. The German market is probably just starting to take off, but it's still a difficult market. On the buy-out side, I think that we are starting to see some spin-offs from the larger corporates, but deal flow from the Mittelstand will take much longer. The Mittelstand mentality still isn't very open to private equity financing. We haven't seen very much activity there yet, but we are very optimistic for the medium term. We would like to invest in some groups with focus on Germany, but we would look very carefully at whether they really understand the German mentality and whether they have access to deals. Scandinavia is interesting and we are also looking at Southern Europe, although we would most likely only invest in a pan-European fund with some allocation there rather than with a local team.'

What advice would you give to an investor who is new to private equity?
‘It's important to have a long-term decision on allocation. Don't rush in. Diversify not only by segment, but also by vintage year. And team up with people with experience, especially if you want to build up an in-house team. If you don't have an in-house team, then work with an experienced advisor.'

What's the biggest mistake that you've ever made?
‘The mistakes that we tend to make are ones that waste a little time, rather than anything more serious. Occasionally, we will see a fund, decide too early to focus on it, spend time doing due diligence and then find that there are some problems. Then we have to abort the process. There are times when we haven't been as objective as we could have been and got very excited about a fund. If we then put it in an objective framework, it doesn't stand up as well. Partly for that reason we tend to invest in a fund's later closings. There is usually much more information available to help us assess a fund. In most cases, it means that we will see the fund's first investments and we will get key references. It also gives time for developments to happen, such as key members of the team joining or leaving. We would obviously be very concerned if one of the key members left. Someone joining is usually a positive thing, but the quality of the team is so important, we want to do due diligence on the whole team that will be investing our money.

‘I would say that the reason we wait is not because we want to see which other investors have committed to a fund. We already talk to a lot of other investors and we know what they are doing, so it wouldn't really influence us. We have often been in funds where we are the only German investor, for example. We do exchange due diligence or opinions with other investors in a fund, but we rely on our own due diligence for our decisions.'

What is the biggest issue for the private equity industry?
‘The consolidation of private equity players and a loss of confidence among investors are probably the biggest issues at the moment. In Germany, funds lost a fair amount of credibility because they delayed writing down the values of their portfolios. After the public markets fell, investors were expecting write downs, but they didn't start filtering through for months. Some are only just coming through now.

‘There is a consolidation of players going on. In Europe, there are a lot of small funds that were first or second-time funds. Often, these won't produce good returns - and in some cases no returns at all. They won't be able to raise successor funds. That will drive the consolidation here. In the US, the issue of succession will play a large role in consolidation. Many funds with older GPs will see some of their senior partners leave, putting a question mark on the funds' future. That's in venture. There won't be such a mass consolidation in the buy-out market, although you will see some problems among funds that didn't stick to their strategies.

‘The weakest are not going to survive. I just hope that this doesn't dent investor confidence further because it should be the strong firms that really add value who will survive. I hope that investors will be able to distinguish between the stronger, dedicated firms that will produce good returns in the future and the weaker ones that entered in the boom times that won't. That way, the consolidation will result in a stronger market made up of good groups. That will be good news for the industry.'

How will the market change in the future?
‘Over the medium to long term, I'm positive about the prospects for private equity. The really good teams will prove themselves and will regain investor confidence.

‘But what is needed is transparency, especially in Europe. We are working on this area with our rating system. We would like to publish the results of our ratings. Obviously, we wouldn't make any friends by publishing the names of funds with low ratings, but we think we could make the best rated funds public. I think that the market needs this type of initiative. There are already some third-party ratings being developed in the US. We are also thinking about indexing. We already do this with hedge funds, but it is harder with private equity. We would need to take the best rated funds and index them according to vintage year. That's a development for the medium term.

‘There is also a real need for liquidity in the market. Liabilities are very tight for German institutions, and I would imagine it's the same in some other countries. They need good cash flow and they need to be able to sell their investments. That will provide a boost to the secondaries market. This is already starting to happen. We've seen a few huge funds being raised. At the moment the deals are quite large and I think that the market will always be dominated by the bigger players. However, I think that there is also a need for buying and selling smaller interests in the secondaries market so we may see some developments there.

‘I think that securitisation may help with liquidity as well. A number of people are starting to do this. This for me is also about creating specialised and customised vehicles for investors to suit their needs better. We offer customised solutions for institutional investors because it's hard to find a structure that suits every type of investor. We are seeing a demand for private equity investing from smaller and mid-sized institutions in Germany. This will start happening in the next two or three years.

‘One recently has seen limited partners starting to get bargaining power. So far, most LPs that have negotiated on terms have been the larger investors. I think some groups of LPs may start getting together to work with the GPs for better terms. The only problem is that all LPs have their own issues and agendas and so it will be hard to get total agreement on all points. But now that GPs are under pressure, it's a good opportunity for them to get together and negotiate sensible terms.'