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Institutional investor profile: Wim Borgdorff, managing partner, NIB Capital

Borgdorff on the benefits of a top-down approach to investing, on the value-adding myth and on the ways in which private equity's increasing maturity affects general and limited partners.

NIB Capital manages the private equity assets of two of the largest pension funds in the world, ABP and PGGM. With fund investment, co-investment and direct investment capabilities, the firm has offices in Amsterdam, New York, Frankfurt and Brussels. It currently has over E14bn under management and is in discussions to manage the assets of other selected pension funds - both large, global players and smaller funds based mainly in the Benelux countries.

What type of investments do you look for?
‘We have a number of activities, including fund investments, co-investments, direct investments and mezzanine investments.

‘In our fund investments, we have a global mandate from our sponsors ABP and PGGM to give them the best structured and diversified private equity exposure. We invest 45 per cent of the fund in the US, 45 per cent in Europe and ten per cent in emerging markets, mainly in Asia. This fund also commits to all investment stages: a third in early-stage technology, a third in growth capital and mid-market buy-outs and a third in large buy-outs. We currently have E9.5bn committed to this investment scheme and we are planning to add another E1.5bn over the rest of this year. Thereafter, we will manage APB and PGGM's overall private equity investments on an exclusive basis, which will mean that we will commit on average E2bn to E2.5bn a year.

‘Within our fund investment, we have the opportunity to commit a substantial amount to secondaries. Of the overall figure going into funds, we can invest up to ten per cent in the secondaries market. In the past, APB and PGGM didn't have those opportunities so we will be helping them catch up on this over the next three years. We envisage that we may well put up to 25 per cent of the money to work in secondaries in a single year, presuming that the market remains as attractive as it is currently. To manage this, we decided to refocus the organisation a little, so we freed up two people who concentrate purely on investing in secondaries. We are very neatly positioned to take advantage of this opportunity because we have the fund investment side so we know GPs, we have strong networks and we have the skills to evaluate fund investment prospects and on the other hand, we have strong direct investment capabilities, which enables us to value portfolio companies. We have decided to take a step-by-step approach and are building relationships with secondaries players so that we may be able to co-invest alongside them. Next to this we are also focusing on our GP networking for direct one-to-one investment opportunities.

‘Our dedicated co-investment scheme targets investments alongside general partners in Europe and the US, but not in the emerging markets because we don't have the expertise there. The scheme is skewed more towards the later stage buy-outs because it is much more straightforward to put our money to work in these types of deal. We do also have an early-stage team in co-investments, though. That scheme has E900m available to invest, of which 45 per cent has been committed. The remainder will be invested up to mid-2003.

‘Our direct investment activities are made up of E1.5bn of investment. Of that, E900m is from our direct investment fund that started investing in 2000 and the remaining E600m is made up of legacy portfolios. We have a good mix of early and late-stage investments in our direct portfolio, but we have a very specific geographic focus for this. We invest only in the Benelux countries and to a smaller extent in Germany because this is our home market. We know it well, have a strong heritage in the market and we have strong networks here in terms of businesses and entrepreneurs.

‘Next to these activities, we have also created a mezzanine fund that targets the US. This will invest 50-50 in US mezzanine fund investments and co-investments. Its overall size is E400m.'

How is the organisation structured to take all these activities into account?
‘We operate as one integrated partnership. We are focused on making use of and sharing the information we gather in each of our operations and the experience in the organisation. We can generate a lot of value through this.

‘Our fund investment team and our co-investment team in particular work very closely together. They share the same set of relationships and because of this, they can add a lot of value to each others' activities. For example, in the fund investments, we can use the experience and knowledge of our co-investment team to review a general partner's previous portfolios. Once you have done a real-life co-investment with a GP, you will have additional information and you know what they are doing, whether they are really equipped to add the value that they claim to add and you understand the way the team works together. We currently have 130 limited partner investments and out of those we have 75 GP relationships that we actually track and spend time with.'

How do you tend to find out about good fund investment opportunities?
‘We have a very strong top-down approach. We are very focused on deciding our allocation on a vintage year by vintage year basis. We look at our allocation first, look at where our money is going and at where we want to be. That to a large extent drives our portfolio planning. Before we rush into the market, we spend a lot of time getting to know what is out there in any one year and, based on that, we do some portfolio planning. So, for example, we'll look at what our thoughts are on pan-European mid-market plays compared to the more local opportunities. We then put all the opportunities on our radar screen, subject them to rigorous analysis and zoom in on the opportunities that make sense to us. Only at that point will we start due diligence to understand what their investment strategy is, where they can add value and so on.

‘From what I've seen, our approach is more top-down than in other funds. We are very deliberate about this. Many other players tend to take the approach of whatever comes to the table, gets attention. We try to be a little more disciplined than that. The aggregate of investments that we make over a year has a lot of meaning to us.'

What do you look for in a private equity manager?
‘There are no universal truths in private equity investing, so it's impossible to give you three things that really make a good manager. We are very focused on understanding what a GP is doing compared to the opportunities he is trying to play. We normally start with a detailed understanding of the segment we are looking at. We look at any available research into that area and then come up with our own assumptions about the market.

‘Everyone is talking about adding value at the moment, for example. But for us, it depends on which part of the market you are playing. If you're looking at large buy-outs on a pan-European scale, then adding value has become very important. But if you're looking at European mid-market deals, then being much more financially orientated can be successful. It's understanding the market and its segments, knowing to what extent the segment is maturing and what the dynamics are.

‘We look very hard at what a firm's stated strategy is, what it is aiming for. Is the fund focused and does the team have a clear idea of what its value-creating opportunities are. Is it correctly positioned to make the most of those opportunities and how is it placed compared with other teams? We then move onto the organisational setting. How has the firm structured itself? How is it organised? Do the people fit in to the overall approach?

‘Only if all that stacks up will we look at the numbers and past performance. We want to find proof of past performance. Has the fund been able to deliver on its strategy in the past?'

Which areas do you think are particularly interesting at the moment?
‘Overall, we have made a deliberate choice to have a well diversified portfolio. We also aim to be very disciplined about where we commit our money. We tend to be pretty modest about having the ability to predict the outcome of investment activities in specific marketplaces over a three to five-year timeframe. Anyone who has worked in asset management knows it is hard to do that with any kind of consistency.

‘Having said that, we tend to have ranges related to the allocation targets we have specified. We are currently seeing that investment activity and deal flow in the US are still very slow. There are some faint indications that things are turning, but I think that it will take some time before things really pick up again there. We have spent a lot of time with US general partners in the venture capital area recently and we have seen that the process of scrutinising their existing portfolios has pretty much been completed. They are starting to invest again now and the number of opportunities available has increased recently and we are fairly comfortable with our investments there. Buy-outs in the US will probably take a little longer to pick up.

‘In Europe, buy-outs have picked up very rapidly and there seems to be a lot going on. If you look at the valuations, the feeling overall is that there are attractive assets for sale at realistic prices. If you look at European venture capital, there is still a lot of trouble related to the difficulties with the VC franchises themselves. It is still an immature market. A lot of new players have entered the market over the last few years and many of these have had their fingers burnt. They will find it hard to recover. I think that the European venture industry will have a bumpy ride over the next few years. But within that, we think that the good GPs will operate in an attractive market. We just have to find the right people and fund them.

‘The emerging markets are rather a mixed bag. Latin America has been spoilt by Argentina, but most of our portfolios are in Mexico and, to a lesser extent, Brazil. Mexico is doing very well because of its strong connections with the US. Israel is in a lock-up situation because of the political difficulties there. In Asia, we are spending a lot of time understanding the main economies there - China and Japan. We want to follow their developments as closely as we can so that we can time our investments correctly. We don't currently invest much there, but we do recognise that things might start moving pretty quickly, so we need to stay close to what is happening.'

What is the biggest mistake you have ever made?
‘On a general level, things have tended to go wrong when we have made decisions based on a sense and understanding of the market that were based on hearsay rather then fact and detailed, well structured analysis. On a more abstract level, it's about following the herd. The private equity community still has strong herd instincts. So we try not to get too close because when you really want to outperform the market, you have to do things differently and have a disciplined and focused approach.'

What advice would you give to an investor new to private equity?
‘You have to be aware that this market is probably past its immaturity. It has become increasingly complex, which means that you really have to spend a lot of resources to make the right choices. If you look back five to ten years, the universe of GPs that investors had to choose from was pretty limited. There were only 50 to 100 that had some sort of stable franchise and a track record. Now, there are probably five to ten times that number. That has added to the complexity.

‘But the strategies have become more complicated, too. The way that firms add value has become much more sophisticated as the market has become more efficient. If you look at the mid-market ten years ago, the value-adding strategy would probably have been a pretty standard financial engineering kind of play. There was nothing else out there. Comparing apples to apples wasn't very difficult. Now, if you were to compare value-adding strategies in a mid-market buy-out firm, there are probably ten different routes to arrive at the same place with very different risk profiles. In 1995, if you went with the brand names, you were unlikely to go wrong. But we all know that a number of those brand names are now people that we wouldn't want to be identified with.

‘Going forward, scale is going to be important. To invest successfully in private equity, you need sufficient resources and intelligence. I really can't see how the one to three-man bands that suggest that they can do a global fund investment programme will work out.

‘So the answer is not to underestimate the complexity of the market. It is so easy and attractive simply to have someone look at the general partners crowding your doorstep to court you. That may have worked ten years ago. But that won't be the case over the next five years and beyond. It is going to be much harder for GPs to extract the value they have extracted in the past because the market has become so much more efficient. The first-mover advantage worked for a time. That time has now gone.'

What is the biggest issue that the private equity industry faces?
‘In the short term, there is an issue of there being a lot of money that needs to be invested quite quickly. With the large funds, there is a fee clock ticking and we all know that taking a long time to invest will affect time-weighted return and performance figures. Economies are going to be slow over the coming couple of years. How disciplined are general partners going to be with their investments? And how are limited partners going to respond?

‘In the longer term, as we have already mentioned, change in the private equity industry will become ever more rapid. General partners will find that the tricks that used to work, won't work for long. They will have to become more deliberate in their strategies, learn new skills and unlearn some of the things that they have learned in the past. These kind of issues are very difficult to address in a partnership. This type of structure harks back to a time when private equity was much more of a cottage industry that was built by learning on the job almost through apprenticeships. But now, it is very much about survival of the fittest and the fittest will be those who respond to the changes, learn new skills and adapt their strategy to a more efficient market.'

How else do you think that the market will change in the future?
‘Improving efficiency of private equity markets will kick in. There is no doubt about that. For people like us, it becomes increasingly difficult to justify our position and show our sponsors what we have been doing. For that reason, we have focused on developing value-adding strategies, such as secondaries investing and co-investments.

‘This will also affect general partners themselves. The current compensation and fee structures were appropriate at a time when the market was much less efficient. Over time, it will become increasingly hard to justify them. Things will change, people have to adapt to it and not rely on old wisdom.'

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