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Institutional investor profile: Jens Bisgaard-Frantzen, managing director, ATP Private Equity Managers

Bisgaard-Frantzen on becoming an investor of choice, on rock-bottom valuations in the US, on what it means to add value and on seeing beyond the distortion created by the last few years.

ATP, the Danish labour market's supplementary pension scheme, recently decided to increase its allocation to private equity. It has created a separate unit, ATP Private Equity Managers (APEM), with E4.5bn of the state fund's capital to invest in the asset class between 2002 and 2005. APEM, which aims to be a leading European private equity manager, is currently implementing a series of measures and putting structures in place to ensure that it functions as a fund of funds and attracts the best investment professionals.

Why did ATP start investing in private equity?
‘In 2000, ATP did an asset-liability modelling study conducted by a global investment bank, which advised the fund on how the investments should be structured. One of the outcomes of the study was that it was feasible to have up to ten per cent invested in private equity, which is much higher than most European allocations. ATP had invested in private equity before, but only in a small way as an addition to our public equities investments.

‘Once we had decided to increase our allocation to private equity, we had to look at the best way of doing it. So we examined best practice across Europe and in the US and decided that, given the size of our programme, the most effective way of investing would be to keep it in-house. We did consider using gatekeepers and other consultants, but we felt that we should build up our own competencies rather than pay someone outside to do the work for us. Once we had settled on that, we split ATP Private Equity Managers from the ATP fund so that we could create the right conditions for attracting the brightest private equity talent and make the best investments for the pension fund. We operate just as a fund of funds would do, only we don't raise funds externally.'

How have you decided to construct your portfolio?
‘We see private equity as an Alpha-driven asset class. We put most of our effort into evaluating different managers in order to be able to select the best ones possible. On top of that, we devised certain broad guidelines. These are that we want to put approximately 65 per cent in buy-outs and 35 per cent in venture capital. We define venture capital as life sciences and IT.

‘Our exposure to venture capital is a little higher than is representative of the private equity market as a whole, but we feel that committing this level of our allocation to venture capital adds some risk-reward features to the portfolio. We feel that, going forward five to seven years in this investment class, venture capital will be a very interesting commitment for us to have had.

‘The geographical split of our private equity investments is 50-50 US-Europe. That is overweighting Europe a little at the moment because the US market is so much larger. But we decided to allocate that way because Europe is growing so quickly - it is increasing in size much more quickly than in the US and it's starting to catch up. Yet we have to take the view that the allocations between buy-out and VC and the US and Europe and not entirely rigid. We will evaluate them further down the road.

‘We also do some co-investments. These are limited right now, but we may increase the amount we do to around ten per cent. We base the decision of whether to proceed with a co-investment on our relationship with a general partner. I strongly feel that when we actively work with fund managers, then they will come to us with opportunities and we will be able to understand their thinking. This makes it rather easier to conduct thorough due diligence and decide whether to invest or not.'

Why have you decided to focus on life sciences and IT within venture?
‘Life sciences is a pure venture play. There are a lot of opportunities in this sector going forward and there is a lot of value to be made from investments in this area. We are living in a knowledge-based economy - life sciences companies typify this type of economy and it's here that you will find an ABB of the future.

‘We are investing in IT because this in a way balances out our life sciences venture investments. The time to market is much shorter and the risks might be lower.

‘But it is important to stress that to make any money out of either of these sectors, you have to be prepared to be there for the long term. If you don't stick to them, you will never be successful. The same is true of private equity investing as a whole, so we are committed for the long term.'

How do you find out about good investments?
‘We want to have a proactive approach to private equity investing. So we have drawn a map of the markets with six segments. If you take Europe, you have buy-outs, life sciences and IT and the same in the US. That's where our six segments come from. We have prioritised certain areas over others. In our process, we have been making survey trips to some of the areas. So we have been to Paris recently, for example, to meet some buy-out funds - mostly ones that aren't raising at the moment. We want to build up relationships with funds so that we are one of the first ports of call if a fund is raising. We realise that not all funds are in the market at the same time, but they will be in the future. We want to know who's out there - not just for now, but for the future, too.'

What do you look for in a private equity manager?
‘The team is possibly the most important factor for us. We look carefully at whether the team is really able to add value. If you take an IT fund, for example, we would look at exactly how individuals on the team had added value to ensure that the company grew. How did they contribute to the company's success? Have they contributed directly to building good management structures, new products, to bringing in new people with the right skills to take the business forward? Have they been clear-minded enough to ask: is this CEO the right person to lead this company?

‘We look for teams that have followed a consistent strategy over the years. We don't like funds that have shifted too much - some buy-out groups, for example, started investing in venture deals over the last couple of years. So we look at whether a team has invested using the strategy before, whether its track record relates to that strategy. Added to that is the process. Has the team looked under every stone to find the best investments? What are their due diligence processes? We look very closely at the terms and conditions - we want to invest in partnerships that have terms consistent with the market standard and in which the general partners' interests are aligned with our own. But I wouldn't rule out that we would be more pragmatic about some of the terms if we were looking at a particularly interesting market or partnership.'

Where are the best opportunities at the moment?
‘Right now we are looking at a number of buy-out finds in the US. These are particularly interesting at the moment because the downturn in the public markets has brought down valuations of private companies in the mid-market.

‘We are also looking at European funds, but on a pan-European level because the consolidation has only just started to materialise here. I think the mid-market play is very different in Europe because it is done very much on a local level. Mid-market funds tend to be country-specific. It's hard to say whether valuations of companies have come down as much as in the US, but vendors clearly have much more realistic expectations now about the value of their businesses than they did a year ago. That's what we're hearing.'

How do you conduct your due diligence?
‘Our process is built in such a way that we are able to screen between 250 and 300 funds a year. That is quite a lot, but that's just the screening stage. From that group, we can conduct due diligence on between 25 and 40 funds. We are very thorough in all our due diligence. We see due diligence as very much about checking firms' claims and seeing that they have been consistent throughout. We drill down into each individual deal, find out how the deal was sourced, whether it was proprietary to the fund, how the fund positioned itself in the deal. Then we look at the pricing, the transaction structure, what the investment thesis was, whether the fund did everything that it said it would do when it first did the deal. We also look at what the fund has done in terms of executing exit strategy, how it has positioned an investment for IPO or trade sale. It's a very in-depth process.'

What advice would you give to an investor who is new to private equity?
‘I think that it depends on the size of the programme. If it is a large programme, it is sensible to build a whole unit to invest, as we are doing at the moment. Our investment team currently stands at eight people, but we are planning to increase that to around 20 over the next few years, so you can see that it takes quite a lot of resources to run your own programme.

‘For funds with smaller programmes, my advice would be to invest via funds of funds. That way, you don't have to be concerned with the day-to-day running of the programme or with the time-consuming and difficult business of manager selection. Funds of funds also ensure that you can get adequate diversification even with a relatively small amount committed to private equity. These advantages come at a price, though, and I think that you have to accept that the overall management fees will be higher than if you invest directly.'

Have you invested in any funds of funds or secondaries funds?
‘We decided to invest in two funds of funds at the beginning because we felt that it was a way of getting rapid access to the market and to diversify our portfolio immediately. We have built relationships with funds of funds because it means that we can talk to them from time to time to assess opportunities and swap notes occasionally. But we haven't invested in secondaries funds for the moment because we are concentrating on making our buy-out and venture investments.'

What is the biggest issue for the private equity industry at the moment?
‘Our biggest concern is that while we are doing our due diligence, we are seeing that the returns on the most recent funds are very poor. So we have to ask ourselves whether the capital that we invest will do much better. The challenge is to see beyond the last few years, which I think distort the market. We are not too over-ambitious in our expectations of our investments, but it is very hard to delve into a fund and evaluate what the future performance is likely to be. It's very easy to be distracted by the most recent figures, which are terrible.

‘This is all as a result of the technology and telecommunications investments made at the top of the market. Why did so many firms become so heavily exposed to these areas? I think that most of the problems that we are seeing now are as a result of firms changing strategy - so many firms that did not have experience or expertise in these areas, but still became involved. Some funds have learned their lesson, but not all.'

What is the biggest mistake that you've ever made?
‘This was before I started my current job and was investing directly in companies. On one occasion I backed a management team that didn't deliver.  When you make direct investments, you are really putting the eggs into the nest of the managers. You have to concentrate on getting to know managers so that you are convinced that they can deliver. With hindsight, there were some tell-tale signs that all was not well. The team was not producing the monthly reports that it should have been - and that spells trouble. If that happens, you have to really look hard at why this is happening. There is usually a good reason.'

How do you think that the market will change over the next few years?
‘My basic hypothesis is that if you could roll back ten years, you would probably see that the current recession in many respects is the same as we saw in the early 1990s. This downturn will be as destructive as the last one was. But it will probably result in a boom period five years from now. I don't think that it will be possible for the US to increase its productivity gains as much in the future, so the public markets may not be as buoyant as they were between 1995 and 2000. I think if you're looking at private equity, you have to take a long-term view to see where the business cycle opportunities are for your investment and plan accordingly. I think that we are near the bottom now, but I can see the possibility that in five years' time GDP growth will be higher than it is now, which is when many of our first investments will be exiting. It is a very primitive way of looking at the global economy, but I think that you have to look at these things in five/six-year stages.'