PRINT THIS PAGE

Institutional investor profile: Rhonda Ryan, senior director, alternative investments, Clerical Medical

Rhonda Ryan on the importance of teamwork, on the operational-financial mix, on the dangers of sector specialisation and on the thorny issue of succession problems.

With a total of £62.3bn under management, Clerical Medical manages assets for Clerical Medical, Equitable Life and the pension fund of Halifax. It has approximately £1.2bn allocated to alternative assets, of which around £900m is committed to private equity.

What type of investments do you tend to look for?
‘We are very much driven by achieving the best investment return for our clients. We aim for top quartile performance first and foremost. That means we look across the board at all sectors and all stages. Our current remit is Western Europe and the US and our current exposure goes from early-stage investments in the US right through to large buy-outs in Europe.

‘Both Equitable and Clerical have been investing in private equity since the early 1980s, so we have two well established portfolios under management. We always look at the mix of assets and try to ensure that there is a good balance of investments in each portfolio. For example at the moment we are looking at US MBO funds for Clerical Medical because it doesn't have many of these in its portfolio. Overall, we think that it is effective to have around 25 per cent in early-stage investments. Likewise we split the portfolio between US and Europe. One of our clients does have some exposure to Asia, but that is not a significant amount.

‘We have invested in funds of funds in the past, but now we have our team of four, we are less likely to do so unless they have a specialist strategy.'

How do you tend to find out about investment prospects?
‘As an established investor, many funds come through the door. Our senior investment team had been running three private equity funds separately before coming under the same umbrella at Clerical Medical. So between us, we have a lot of contacts in the private equity industry. We also go to conferences and ensure that funds know that we are in the market and that we are investors.

‘On top of that, we look at the market to keep up to date with who is currently raising and who is likely to be raising in the future.'

How do you assess investments?
‘We are very focused on getting into the top quartile performers, so we look firstly at track record. But it's more than that. It's all very well to have great performance in the past, but we want to be convinced that fund can replicate that in the future. If all the main partners had left, for example, or if we thought that the strategy no longer worked in the current market environment, then we would not be interested.

‘We then have a very good look at the management team. We will interview them very extensively, wherever they are based. We want to get a feel for what drives and motivates them. We also look at the team dynamics. . For us, the fund has to be working as a team and not be too dependent on one person. We look closely to see if there are any succession concerns - that's a big issue at the moment, particularly in the US. So, when we're talking to long established funds , we want to see evidence that they have addressed succession issues. If they haven't then that raises alarm bells with us.

‘We produce full due diligence reports. Then, we put each investment to our team here at Clerical Medical. We have to reach a consensus view  before we will approve an investment and make a commitment. If the person putting forward an investment proposal can't persuade the team that is right for our clients then the investment doesn't get done. We believe that this approach mitigates risk and enhances investment returns.'

What do you look for in a fund manager?
‘We tend to like fund managers who are still keen. We see many people who have already made a lot of money through carry and you have to ask yourself whether they are still hungry enough to do good investments.

‘We like to see that a fund has a solid team and that it is encouraging its younger members to progress through the company.

‘There are a lot of sharp minds in the business - we want to be invested with them. We also take reference checks from portfolio company managers. We want to get a feel for whether a general partner adds value to their investee companies. We're not keen on groups that rely solely on financial engineering for their returns. We want to back hands-on managers.

‘As for specific skills, we are seeing a lot of firms combining financial people with operating partners, particularly in the mid-market. It's happening more so now than even three years ago. Once upon a time, you could get pretty good returns from highly leveraged deals, but the financial markets have changed and the banks are lending less and that's changing the way that you have to do MBOs.

‘There is a lot of attraction in that operational-financial mix. Those people with operational experience have run a company before, they know the real thing rather than just the theory. They are used to dealing with, for example, marketing or sales and are used to turning businesses around. So we like to see operational skills in a team. With early-stage teams, we want to see evidence that they can assess business plans. There are a lot of great ideas out there, but what counts is whether you can translate them into products and sales, and eventually profits.

‘And, very importantly, we look at exits We like to see that managers have thought about how they are going to exit an investment even before they commit to it. It is great to make a good investment but it's at least as important to be able to exit that investment.'

Do you invest in first-time funds?
‘We are cautious about first-time funds. We would need a lot of convincing to persuade us that the team was worth backing. We'd need evidence that the principals had excellent personal track records. If there was no track record, I think that we'd find it hard to justify. We would obviously have to do a lot of due diligence on a first-time fund to satisfy ourselves that they were worth backing and would provide us with something that an established firm with a track record might not be able to deliver. We would also focus very heavily on the team dynamics. New teams will generally have teething problems and we have to be convinced that the Partners can work together. If we're not convinced, then we'd probably take the view that we should wait until they raise a successor fund.

‘We haven't yet invested in a first-time fund, but we are currently looking at a spin-out.'

Which areas do you think are the most exciting at the moment?
‘We are focussing on the US and Western Europe. For the time being, we wouldn't go outside that geographic focus. We also tend not to be too focused on sectors. Some funds have come to us that are very focused. Ten years is a long time to be signed in for and these funds have a five or six-year investment period. Is it really possible to decide which sector will consistently be the best one for this length of time? I'm not so sure. Funds that are very sector focused are still going to have to invest their capital and exit their investments, even if the markets turn against them. You could well end up with the best of a bad bunch of sector-based investments in your portfolio if you are too narrow in your focus. Funds with a broader remit are much more able to take advantage of opportunities as they arise.'

What is the biggest mistake you have ever made?
‘Thinking that investing directly into companies would be a good thing to do. I never actually made any direct investments because I inherited some direct holdings and learnt quickly how time-consuming they were. When a company needs attention, it needs it straight away. You have to drop everything. It's also a totally different skill set - we shouldn't be trying to compete with the funds that we invest in. They have the skills to invest well in companies and manage their investments. That's why we invest in them.'

What advice would you give to an investor who is new to private equity?
‘Take your time and develop a program. Don't be in a rush to invest. We are very careful about our vintage year exposure and I would advise others to be the same. Years do differ in performance, regardless of which funds you are in.

‘There is nothing like experience - on the investor's side and on the general partner's. If you are a new investor, be prepared to hire someone, or preferably a team, that is experienced in private equity to manage the programme for you. Alternatively, think about going the fund of funds route. Certainly, the fees are there, but if you look at the difference between the top and bottom performers in private equity, you'll soon realise why getting in experts to do the job for you is so worthwhile. You really have to make sure that you get into the top quartile performers because it makes a huge difference to the kind of returns that you will receive. If you are going to do it, do it properly and make sure that you have the expertise. There really is no substitute for private equity experience - it is different from other asset classes, so you can't just rely on the people who manage your other assets to invest in private equity for you.

‘Take a very wide view of the market. Compare with other groups that are in the same space. Don't just take the first one that comes through the door. Everyone claims to be in the top quartile, but not everyone can be. Don't look at a fund in isolation. Be selective. Very selective. Question teams about why they are different from other venture capitalists. What is the strategy that they employ? Look very closely at how cohesive the team is and look to see whether succession has been taken care of. If you're new to the market, you may be tempted to see a fund that has been going for 20 years and think, “that's good enough for me”. But if Mr X at the top of the firm is 70, he is unlikely to be with the firm for that much longer.

‘Always keep in mind that it is a long-term asset class. You will get ups and downs, so don't stop and start your programme. If you want to invest in private equity, go in realising that you will experience the J-curve effect on returns and there will be times when returns are not good. But over the long-term, provided that you've backed the best teams, the statistics show that the asset class outperforms the others. Be patient. Don't look at one-year returns - they are meaningless. So what if returns were up by 100 per cent in a couple of years? So what if returns were down 30 per cent over one year? It's not an asset class that should be viewed on a one-year horizon.'

Do you think that the start-stop mentality has been a problem recently?
A lot of investors went into private equity in the late 1990s with the expectation that it was a great place to make money. Then, when the market went sour, they pulled back. That doesn't help the market and arguably now is a good time to invest. Company valuations have gone down and if general partners are able to find attractive deals and source the debt for these, they should be able to make some very attractive returns. The danger is that those investors that went headlong into early-stage when the market was overheating will now pull out as they have seen their poor investment returns.'

What is the biggest issue in the private equity market at the moment?
‘Succession. There are a lot of firms, particularly in the US, that have been in operation for 20 or 30 years. If they haven't addressed succession , they will have a problem. But even if they have, we would always question whether it is working. We like to see the younger partners making a worthwhile contribution. We like to hear from the CEOs, for example, that the younger members of the team are active on their boards. Ideally, we'd like to see them getting a fair share of the carried interest. Even in firms where senior partners are likely to be around for some time, succession is an issue because you can never be sure about what might happen. We like to see that firms are prepared to talk to us about it.

How do you think that the market will change in the future?
‘There will possibly be a lot more money entering the market. The Myners Review in the UK, for example, should encourage more investors to invest in private equity. My main concern with this would be that they understand what they are investing in. It would be very disappointing for the industry to find that the newer investors just thought it was a great idea because Paul Myners said so and then pulled out of the market because they had a negative experience.

‘There will probably be more global firms. If you talk to US venture capitalists, many of them are considering setting up offices in Europe, if they haven't already done so, or about going into the Far East.

‘The industry will become more developed. There is certainly room for this in Continental Europe. And I wouldn't be surprised to see more private equity activity in the Far East - eventually. It may be some time before it really does takes off in the Far East. If you look at places like Japan - I visited there recently and I used to work at the Industrial Bank of Japan - there are potential opportunities, but it's a cultural issue still. There is a lot of restructuring to be done but it's not happening just yet. In Japan, it's a lot harder to go in and do large scale restructuring, making lots of people redundant, for example. A lot of people rushed into Japan quite early and committed money to Japanese funds, but much of that is still uninvested.

‘The issue of the weight of money will probably be one that plays out in the future. I think that the market can take more, particularly outside the US, but there will come a time when the amount of money being pumped into private equity will start dragging down returns. I just hope that that time doesn't come too soon.'