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Institutional Investor Profile: Topi Piela, Director, Finvest

Piela on the importance of teamwork, on why venture is harder work than buy-outs, on the correlation between public and private equity and on keeping portfolio company managers motivated in a downturn.

Based in Finland, Finvest is a listed private equity fund of funds. It is a relative newcomer to the market and has a strategic partnership with Swiss fund of funds player LGT Capital Partners. To date, it has made eight fund investments totalling E33m to funds such as Atlas, Benchmark Europe and Industri Kapital. Piela was previously at Ilmarinen Mutual Pension Company, Finland's second largest pension fund where he was responsible for E4bn of equity investment, including private equity. He has been in the asset management business since 1986 and in private equity since 1992.

Why have you decided to be a listed fund of funds?
‘We have been going in our present format for one and a half years - Finvest the company has been going since 1897 and gradually became a conglomerate. It has since been split into four companies, of which we are one.

‘Private equity has outperformed public equities over time and that's what we want to offer for a variety of people. Typically private equity is open only to institutions and extremely wealthy individuals. With a listed product, smaller institutions can have access to private equity as can private individuals.

‘The fund is a publicly listed company on the Helsinki stock exchange and we operate from a fixed balance sheet. The only way we can get new capital is to have new share issues. That means that it really is evergreen. Ours is the first publicly listed fund of funds in the Nordic countries.

‘The fact that we are a listed fund of funds also that means that we are not a blind pool as other fund of funds are. That gives our investors some transparency. They know which funds we have invested in and we publish at least those funds web pages so that our investors can at least go and see for themselves where these funds have invested.

‘Of course one of the disadvantages of a listed vehicle is that you receive all your commitments in one go rather than drawing them down as you invest. That obviously dilutes the IRR, if you are not able to invest the whole cash balance during a reasonable time. So we will be making smaller gradual share issues in the future.'

What type of investments do you look for?
‘Most of the money will be invested in buy-outs. Our strategy is that over 50 per cent will be in that sector, the rest in venture capital. Europe is our core area. Put simply, European buy-outs is our core area. The allocation as it stands today is ten per cent in the US, 90 per cent in Europe, 60 per cent in buy-outs and 40 per cent in venture.

‘We also decided that Finvest could be active in the secondary markets and in the one and a half years we have been going, we have been involved in that market twice. First, we sold one of our investments over six months ago and we have since bought an interest in EQT.'

Why have you weighted so heavily towards Europe?
‘We've done this for a number of reasons. One is that we discussed our strategy with some potential shareholders in Finland. They felt that they did not want to see a high currency risk in the portfolio. Concentrating on Europe obviously achieves that.

‘Of course, the US market is much larger than Europe. But I think that Europe has a lot of potential. We have a less mature market than the US, and that offers us plenty of opportunities. I really believe that Europe is an excellent place to be if you are in private equity.

‘The other advantage, of course, is that there is a lag between the US and Europe so that means that you are able to react if you see developments happening in the US because you know that a similar thing will happen here. For example, the venture crash happened first in the US and you knew that it wouldn't be long before we saw venture financing falling over here, albeit on a smaller scale. It means that, to a certain extent, you have a window on the future.

‘I should also add that we know Europe much better. We have better information on Europe. When you're investing in private equity, the most important thing to focus on is the team and if you really want to get to know the team and what they are doing, you have to have the information available to judge that and be able to visit them at short notice. We couldn't do that if we were mainly invested in the US and sitting here in Finland.'

How do you tend to find out about investments?
‘We have an extensive library containing hundreds of PPMs and so we know who is out there. We keep up to date with all the journals and trade press. We are also able to source new investment prospects from our relationship with LGT Capital Partners. It takes a lot of time to keep up with everything that's going on - there are two of us doing this. But I should add that a lot of funds visit Finland and so we get to meet many teams that way.'

How does your relationship with LGT Capital Partners work?
‘We have an agreement with LGT so that they open up their deal flow for us. We are also able to use their due diligence - which I believe is the most important aspect of private equity investing and is therefore a critical part of our co-operation. We also have a joint investment committee that looks at potential funds and then makes recommendations to the Finvest board of directors. LGT also helps us with some of our monitoring and reporting functions.'

Do you invest in first-time funds?
‘We try not to invest in first-timers. We will only consider first-time funds if a team has worked together for a substantial amount of time before setting up on their own and they have a good track record. The way that a team works together is of paramount importance - I'm not sure that we would want to take the risk on a group of people who have never worked with each other before.'

What do you look for in a private equity manager?
‘Experience is extremely important as is track record - where it came from, whether it is consistent or whether it is dependent on just one or two really good, lucky deals.  But we also look at a fund's strategy - we don't want to invest with people who have tried to do everything. They need to have some kind of defined strategy and to have stuck to it. Funds need to be doing what they know. So we look at funds that are continuing to raise similar-sized funds as they have in the past, doing similar types of deals. That is a good indication of whether they can really add value to the companies they invest in - they've done it before and know what's needed.

‘I think that the skills needed vary between venture and buy-out. Buy-outs can still be dependent to a certain extent on financial engineering; venture is much harder work. Venture guys need to have some grey hair, especially now that we are going through tough times, you really need experience of working in business, know how to struggle with portfolio companies and make them work. If you have that kind of experience, it gives you a good idea of which ones you should continue to finance and which ones you should walk away from.

‘We look for managers who can really tell you how a technology or a service or a strategy can be implemented to maximise returns on investment. Sometimes, teams don't actually understand how best to maximise returns. There is such a wide dispersion of returns between the top and bottom quartiles that it is so important to get the people who really understand what they are doing.'

What's the biggest mistake that you have ever made?
‘I would have to admit that I made one or two mistakes, along with other investors, in 1999 and 2000. I'm not sure that that can be classified as a mistake - I was reacting to market conditions, as everyone else was.

‘But I think that the most important lesson from all this is that you really get to know and go and see the teams that you are investing with. Meeting one team member tells you nothing at all. You have to see how the team works together, look at what they have been doing and how they have added value over the long term.

‘We are able to make direct investments at Finvest, but we haven't made any yet. I think that maybe my biggest mistake has been direct investments that I have made with my own money. You can't invest in companies if you don't follow exactly what is happening. You really have to get involved. You can't just commit money with the attitude that you are a financial investor and then hope that the others will take care of it. You have to be a board member and be there at all times. I have learned through this that the management team is the most important thing. That's why I look for fund managers that are not just board members but that can prove that they are active between board meetings - that is key to successful investing. Many investors claim to do this, but many get no more involved than attending board meetings. Many don't deliver anything at all - that's what I hear from investee companies.'

Will you invest directly in the future?
‘We won't be doing direct investments for a while yet. We've only been going one and a half years so we are still in our growth phase. We want to add more funds into our portfolio and ensure that we are well diversified before doing direct investments. We have eight investments so far. That's OK, but it's not enough. A fund of funds needs at least 12 fund investments to achieve a good level of diversification. We need to have done that before investing or co-investing. We'd also need more resources - it's a totally different skill set.'

What advice would you offer to an investor who is new to private equity?
‘New investors need to know that, of course, private equity can offer higher returns than other asset classes. But they need to take into consideration the fact that there is a correlation between private equity and public equities - that means that it is subject to volatility in the same way as public markets are. It is cyclical. So there is risk there. I would say that to start off with, the easiest way to invest in private equity is to find a fund of funds. They will give you diversification and expertise.

‘Also bear in mind that you should invest over time. Don't commit your money all at once. If you have a five per cent allocation, start with one per cent one year, then two per cent the following and so on. Build up your portfolio over three to four years.'

What is the biggest issue for the private equity industry at the moment?
‘One of the main issues for the industry and particularly for investors is that the difference between top and bottom quartile funds is huge - especially at the moment.

‘The valuation methodologies I think are also misleading. Valuing portfolios year on year focuses people's attention on the short-term performance of a fund and that isn't very appropriate in an investment that should last for ten years or more. The most important number to focus on is the total return. The NVCA and EVCA guidelines are fine, but I think that fund managers should use their common sense when valuing companies as much as following technical rules. WE all need more transparency and we all need a good relationship between general and limited partners so that we know we are all aiming towards the same target.

‘I think that another very important issue at the moment is how a fund manager can keep his portfolio companies happy in the current climate. Look at it this way. So many companies have dropped in value over the last couple of years, there are also liquidation preferences and dilution issues. You may very well find that the managers of a company see themselves as hard-working people that are not going to see much reward for all the effort they are putting in - they have little ownership left in their companies. How can fund managers motivate these people. The good ones will have to find ways of addressing this.

‘The secondary market is growing out of the turbulence that we've seen in the markets. There are a lot of secondaries for offer at the moment. I just hope that those investors getting involved in secondaries really know what they are doing because it is very different from fund investing.'

How do you think that the market is likely to change in the future?
‘I think that US allocations will hover around eight to ten per cent to private equity; Europe will follow, but to a lesser extent. I think that in the near future, a typical European allocation will be around three to five per cent. This will, of course, create a demand for private equity. At the same time, I think that the number of teams will decrease.

‘I think we may see more listed funds of funds. Today, private equity is either an investment open to ultra high net worth individuals or to institutions; I think that there is some demand from other investors and that will create a demand for alternative structure to the usual limited partnership. I think that the main barrier to that demand, though, is the issue of transparency. How do you report the investments and progress of funds to your shareholders? I think that's the difficulty.

‘We have had the hype. We've got through it. That means that there are now plenty of opportunities out there for good fund managers. If you look at the IRRs of funds with early-1990s vintage years, then you see that they are much higher than those with a later inception. The conditions are fairly similar now to the early-1990s so I think that is a cause for optimism. It's a good time for new investors to come to the market. I think that the economy is likely to pick up over the next half of this year and will gain momentum in 2003. I really believe that we will start seeing synchronised growth very soon from the US, Europe and Japan. The exit market will also re-open next year.'

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