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Institutional investor profile: Jos van Gisbergen, director of alternative investments, MN Services

Van Gisbergen on why European private equity will outperform the US market, on the pitfalls of investing in mezzanine, on the difficulties of finding distressed opportunities in Europe and on why management fees will never come down.

MN Services is the administrator of insurance and collective provisions for the Dutch engineering industry. It became an independent entity in January 2001, with the aim of increasing its size threefold over four years, mainly through mergers and acquisitions. With E20bn currently under management, it has 4.2 per cent invested in private equity and anticipates increasing this to five per cent by the end of the year.

What type of investments do you tend to look for?
‘We invest in buy-outs and venture capital. These investments are spread across the US and Europe. So we invest right through the spectrum from mega-funds through to mid-market buy-outs and small venture funds. We currently have 80 per cent invested in the US and 20 per cent in Europe. We will be changing that mix over the future to bring our investments in Europe up to 35 to 40 per cent and 60 per cent to the US and the rest of the world. We anticipate investing around five per cent in the rest of the world, by which I mean emerging markets.

‘We feel that Europe is an up and coming market. There is a lot happening here. We have one European community, we have one currency that most economies have signed up to and others will follow. There are a lot of inefficiencies in the European market so there are better opportunities here. We expect Europe to outperform the US over the long term because it is so much more inefficient.

‘Our focus in the emerging markets is on Asia because we feel that it is more developed than areas such as Latin America, which is so unstable. We are also looking at Eastern Europe, which is in the early stages of development, but will really start picking up when the accession countries join the European Union. Their currencies will be more aligned with the euro and so currency risk will be eliminated.

‘The only thing that we exclude is mezzanine. I think that we are quite unusual in this, but we take the view that we already have an exposure to high yield distressed debt in other parts of the entire portfolio, so why should we get more exposure through our private equity investments?'

What's the mix of your fund of funds investments to your direct fund investments?
‘Over the last five years, we have been looking to increase our investment in direct funds. We used to invest a lot more in funds of funds, but we invest only in specialist funds of funds now. We commit to funds of funds that invest in early-stage venture capital in the US, for example. That's partly because we don't have our own office over there and so we can't necessarily source the best deals, but it's also because these funds tend to be very small and so it's very difficult to allocate substantial money if we have to invest directly.

‘We currently have three investment professionals and four support staff and we intend to expand our team because we want to do co-investments in the future. This is because you can increase your allocation in a more controlled way than through fund investing and also because it saves on the high burden of expense. We believe that the external costs involved in private equity are much higher than they should be.

‘This means that we will end up committing to funds that will offer some amount of co-investment opportunities - that's generally the smaller funds, who see a lot of deals that they would like to do but that wouldn't otherwise have the capital they need. The larger funds have enough money and so can do almost any deal they wish without offering co-investments.'

How do you tend to find out about good investments?
‘We find out about investments partly through gatekeepers, partly through reading about who is out there and partly through being active in seeking out groups. We talk to other investors and to general partners to source groups, too. General partners tend to be a good source because they know who their best competitors are. There are also increasing information sources on the market that can help us in our search.'

How do you construct your portfolio?
‘We take a mixture of top-down and bottom-up approaches. We look at the macro-economic environment to set our allocation targets, but we also look at who's out there to find the best teams. We need to have some structure to what we do, but we do also need to be opportunistic, too. We decided a year ago to switch some of our allocation into distressed opportunities, for example.

‘It's hard to find distressed opportunities in Europe. What we've seen so far is that there are few distressed companies that try or succeed at restructuring. If a company is distressed, it usually ends up bankrupt because of the social, labour and political culture in Europe. The US market is very different because it has a very different regulatory environment that makes it easier to turn a company around. That, in turn means that there are many more firms specialising in this type of private equity.'

What is your future allocation to private equity likely to be?
‘It is likely to stay around the five per cent mark for the near future, but if we expect private equity to outperform public equities, then we may increase our allocation to six to seven per cent, but not much higher - certainly not to the levels that we have seen in some of the US endowment funds. It doesn't need to be much more because if you have a long programme and you are a certain size, you have to keep on re-investing capital as it is distributed to you. Remember, too, that we are looking to triple the amount of assets under management, so the absolute amount will increase substantially over time.'

What do you look for in a private equity manager?
‘The only way that we can assess whether a fund is any good is by looking at the team. We look at what they have done in the past and assess what they are likely to be able to do in the future. We will only invest in quality groups that have an in-depth understanding of the market and industry in which they operate. They need a financial-operational mix and they need to be able to grow the businesses that they invest in through their personal contacts and through their experience and knowledge. The days of financial engineering are over. We don't want to invest in groups that work on multiples.

‘We also want to see transparency. We want to be able to become involved in what they are doing, to have a full and open dialogue with them rather than just being a financial sponsor. And, of course, that is key when we are doing co-investments alongside our GPs.'

What is the biggest mistake that you have ever made?
‘I would say that the biggest mistake this organisation ever made was when it started its private equity programme. This was more than ten years ago. It started an in-house programme and it was limited to the metal industry. That meant it was only sponsoring troubled clients. The good thing is that we survived this and we learnt a fantastic lesson that has helped us throughout the whole programme. We now understand what the pitfalls can be.'

What advice would you give to an investor who is new to private equity?
‘It depends on the size of the programme. If you have a small programme, don't go for a few individual funds. Go instead for a few good quality funds of funds. Don't go to too many because if you go to five or six, then you will end up in the same underlying holdings twice over or more. Choose one or two good, global funds of funds and then go for a couple of highly specialised funds of funds - US venture for example or European venture.

‘Invest in secondaries early on. That will help your cash flow and liquidity position.'

‘Always have a clear target allocation, but make very precise cash flow projections so that you can be sure of meeting your target. Be prepared for the fact that capital drawdowns are unpredictable in nature. This is one thing that we have learnt over the years and that is why we are not faced with the situation of not hitting our target at a time when the market has slowed dramatically.'

‘If you are a large investor again, first set out a clear strategy and target. Be certain about what you want in your portfolio. Don't invest too much in smaller partnerships because it makes no sense to have 100 partnerships on board, all in the same sectors and running after the same deals. It may seem as though you are diversifying by going for many partnerships, but remember that there are only a finite number of good funds out there. Plus, if you are invested in too many partnerships, you won't be able to be active with the partners or involved with the fund. You won't learn about the business or how particular partnerships think or operate. All you'll be looking at is 100 capital call requests or distributions.'

What's the biggest issue in the private equity industry?
‘I think there are two big issues. One is a lack of transparency in the industry and the other is the fee structure. In the first, there is an absence of a good, solid, quality benchmark. If you were to believe the ones that are currently compiled, then you'd have 80 per cent in the top quartile and 20 per cent would be the pooled average. I would like to see an overview of all funds in the market. All funds should have to provide their final and correct figures to one big database and from that, we could get some meaningful benchmarks. The national and regional venture capital associations are missing an opportunity here. They should insist on all their managers providing them with live, quality information so that they can find the average, which in a normal market, would be called an index. From that you could then select the managers that are doing better than the average and you'd see who's doing worse. Plus, with this type of information you'd also get a better picture of how volatile the market actually is.

‘As far as the fee structure is concerned, the fees that are paid in this industry are extraordinary. If you compare them to those charged by an asset manager in the equity market - they have to work extremely hard for ten or 15 basis points - you'll see what I mean. The mega-funds in the private equity market are the worst offenders. For them to manage billions of dollars, charge a two per cent management fee and then on top of that take 20 per cent in performance fees is just outrageous. Sure, they have hurdle rates, but they are usually set at six to eight per cent and yet they promise you 20 to 30 per cent return. If they really expect to produce such high returns, then they should set their hurdle rates at at least 15 per cent.

‘An appropriate level of management fee, in my view, very much depends on the quality and size of the team. It should be just sufficient to bear the operational expenses. The rest should come from the performance fee. If you have a mega-fund that has around six investment professionals plus some support staff, it should not be charging the same percentage as a restructuring or turnaround fund with 15 or so investment professionals. There is a lot of pressure on this issue from LPs but I don't see it happening. GPs won't change on their own and if they do decide to lower their fee, then their reputation could suffer - people will think that they have been forced to lower their fees because they have done poorly and are willing to take less.'

How do you think that the market will change in the future?
‘The market will become more dependent on institutional money. Private equity firms will increasingly get their capital from pension funds, whereas in the past, they sourced their money from the banks. The banks are committing less and less to private equity now. They started doing it so that they could win lending business, but if everyone is doing it, then it means that you have no competitive advantage in winning those new clients.

‘You will see fewer firms, but they will be better quality and will be backed by good quality institutional investors who have a good working relationship with their GPs.'

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