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Institutional investor profile, Ari Jauho, vice president, private equity and venture capital, Pohjola Group Insurance Corporation

Jauho on the rise of private equity investing in Finland, on the importance of stock-picking in the asset class and on the vagaries of valuations.

With a total of E9bn under management, Pohjola also manages the assets of Finnish life assurance group Suomi Mutual. Considered one of the Finnish pioneers of private equity investing, Pohjola has been investing in the asset class since 1988 and its current assets under management  stand at around E550m.

What type of investments do you tend to look for?
‘Up to now, we have mainly been investing in buy-outs, particularly mid-market buy-outs. That is likely to remain our focus for the future, too. Our target allocation to buy-outs as a whole is 50 to 70 per cent of our private equity investments, our target for venture capital, 20 to 30 per cent and for mezzanine, 20-30 per cent. Our actual allocations at the moment are: 55 per cent in buy-outs, 15 per cent in mezzanine and 30 per cent in venture.

‘We want to focus on mid-market buy-outs because we are not a huge investor and we feel that we can get better positions in some of the smaller funds. We also believe that there are far more opportunities open to the smaller, local buy-out funds. There is a good supply of deals, it isn't a very competitive market, it isn't very efficient and the prices tend to be good. We tend much more towards the country-specific teams, the ones with the local knowledge, expertise and deal flow. We do have some pan-European investments and that's how we started out investing but that is changing now. With the larger funds, the large buy-out opportunities in the pan-European market are quite rare and there is a lot of competition for each deal.

‘We do invest in the US and our target allocation is 20 per cent, but we tend to invest there via funds of funds, split 50-50 between venture and buy-out.

‘As you can see, our bias is mainly towards Europe. This is partly because of currency risk and partly because we know the European market much better than the US market. It's also a resource issue. We don't have the people or time to devote to investing on a large scale in the US. If you think about where we are based, it is relatively easy to keep up to date with and maintain relationships with GPs in Europe if you are in Finland. It would be very hard to be involved in US funds. That's why we use funds of funds for that market.

‘We invest in some secondaries funds. But I have mixed feelings about them. In some senses I am keen because of the vintage year diversification that they can give your portfolio, but on the other hand, I don't think that the supply will be as great as people are expecting and the prices won't be as low. We are already invested in Lexington Partners and we might make another secondaries commitment, but probably someone making smaller deals. The other thing is that you have to take a top-down approach to investing in secondaries because they are more heavily reliant on what is happening in the wider economy.'

How do you tend to find out about good investments?
‘We do a lot of research internally. We follow the market and the players very closely. We are also approached by placement agents on a regular basis.

‘But we are finding that our own deal flow is increasing year by year. When you have been in the market for a while, people get to know you. This has happened particularly since we set up a formal private equity programme in 1995. We have seen much stronger deal flow this year, although I suspect that that has something to do with the difficult fund-raising climate.

‘If you look at the private equity allocation statistics, Finland allocates a high amount when you consider the size of our population and country. And it's increasing. It seems to be a feature of the Nordic market. And historically, Sweden, for example, has been much more active in private equity than Finland. But I saw some figure recently suggesting that Finland is catching up. One of the reasons for this could be recent events on the stock market. We are now able to invest more in private equity because we were heavily exposed to Nokia shares, which did extremely well between 1994 and 1999. All this means that firms are starting to look much more seriously at Finnish institutions.'

How do you construct your portfolio?
‘We take a bottom-up approach to investing in private equity, except for secondaries. We are very much of the opinion that you should stock-pick in this asset class rather than take the index approach. You have to choose your funds very carefully. There is no sense investing in this asset class using an index because it has everything to do with selecting the right teams with suitable investment policies. The thing that makes a difference in private equity is the managers you choose. They have the ability to change and grow a company because they tend to have some kind of controlling interest.'

How many investments do you expect to make this year?
‘We have invested in three funds so far this year - two Finnish funds and one German fund. I think we will invest in another four to seven over the next eight months or so.'

What do you look for in private equity fund managers?
‘The most important thing for us is the team. This is a people business. Track record is important, but I think that the investment team and investment policy are more critical to success.

‘The team has to have experience - and by that I mean experience of venture capital and private equity investing. We don't want to invest in a bunch of investment bankers having a go at private equity. We appreciate hands-on managers and we expect managers to make lead investments so that they are heavily involved with their portfolio companies. Private equity is a very expensive business when you take into consideration management fees and carried interest. Managers can become very rich and so we want them to work for their money, otherwise we could just go off and be passive investors in private companies ourselves.'

‘We want to meet as many of the team members as  possible. We believe that the chemistry has to be right between the team and between us and them. This is a long-term commitment and so we want to be comfortable with the people we are backing.

‘Our criteria are mainly qualitative rather than quantitative. If it was just a case of looking at a set of numbers and putting them into a software package, it would be easy to choose who to back, but I don't think that's the best way of doing it. Having said that, we do look for stable returns. Consistency is important for us. We aren't looking for high risk, high return private equity investments. Our target return is 15 per cent a year. That includes mezzanine, which obviously generates lower returns and hopefully has a lower risk profile in general than venture or buy-out.

Which areas do you think are particularly interesting at the moment?
‘There has been a lot of talk and hype about biotech recently, now that technology is supposedly “out”. This is worrying in some ways, but there may be something in biotech that you didn't get in technology. There is value in biotech because of the intellectual property companies in this sector tend to be built on - it turned out that there was very little of that in technology.

‘Diversification is key to investing in private equity. We always invest across a broad spread of European countries and, of course, in Finland. So I think that Europe as a whole is a promising market. In terms of individual markets, I think that Germany has the potential to be a huge market and has been promising a lot for a long time, but it's not delivering yet and I think it's a while before it will do so.'

What's the biggest mistake that you've ever made?
‘We've managed to go through the tech hype relatively unscathed - so far. Of course, we still don't know for sure, but I think we have weathered that storm pretty well. Most of our venture investments had limited exposure to dot.coms. However, we did invest in one Swedish fund that has taken quite a hit from its technology investments and so I think that may have been a mistake. Our venture exposure is mainly in Finland and the US. In Finland, there were very few funds that invested heavily in dot.coms. They were mainly in the mobile space instead.

‘But maybe it's still too early to say because there are still plenty of write-downs to come. The returns figures that we have seen so far for last year I think are way too optimistic. There's a lot more bad news to come.'

What advice would you give to an investor new to private equity?
‘Take a long-term view. This is a long-term asset class and so you have to commit to it over the long term. You can't start a programme if you're thinking about two to five years. When you start a programme, it's for ever.

‘It takes ten years to build a portfolio. You have to allocate a sufficient amount so that you can get adequate diversification between the sub-classes of private equity, different economies and sectors and, most importantly between vintage years. Some funds of funds made the mistake of going into venture only in 2000. You have to have diversification over several years in your portfolio. It needs long-term commitment on an ongoing basis.'

What's the biggest issue for the private equity market?
‘The biggest issue in the market is really faced by the venture players. They are having to make some pretty tough choices at the moment about which companies to continue backing and provide follow-on funding. Arranging finance rounds for venture-backed companies is extremely challenging at the moment and I think that it is a real shame but many companies with real value, and that would almost certainly be winners in another market, will not get the funding that they need to succeed. Having said that, there is a lot of rubbish out there, too. Many venture firms will be clearing those out of their portfolios and that can only be a good thing. But choosing the right ones to continue backing will be extremely difficult.

‘I think that another important issue at the moment is discipline about valuations. It's hard to say whether valuations have hit rock bottom, and so firms need to be extremely disciplined to ensure that they are not paying too much for companies. That obviously destroys value. I think that this is always very important. It's a question of being selective, and good managers will always pass on many deals and only invest when the price is attractive, the business plan stands up to scrutiny and the business itself is a good one. I think that one of the problems is that many firms end up making as many deals as possible in a bid to grow larger. What they really need to be doing is only investing in a few, select deals that have real potential and then manage them actively and get involved with the businesses.'

How do you think the market will change in the future?
‘I think that the Continental European market will become more mature. That is a good thing. Private equity is already becoming a more mainstream asset class and I think it will be more so in the future. As a result, allocations to private equity from institutions will increase. That will mean that they will increasingly have their own private equity operations, their own investment professionals dedicated to the asset class.

‘I think that private equity has now got over the hurdle of being a “fashionable” asset class. Too many people came in to jump on the bandwagon. But what they didn't realise is that it is not easy to invest in private equity. I think what we're seeing now is business as usual and I hope that is how it will stay. I think it will as the market becomes more mature.'

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