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Institutional investor profile: Wayne Harber, Managing Director, Hamilton Lane

Harber on why Europe is exciting, on inaccurate performance figures, on aggressive GPs and on being realistic about your return expectations.

Established 12 years ago, Hamilton Lane has committed over $25bn to private equity. It has more than 100 institutional clients from across the globe - the majority of them non-US. The firm acts as an advisor and manages funds of funds. It currently manages $5bn of discretionary assets and expects to see this increase as more new investors enter the market. Harber is responsible for the firm's international marketing efforts and for new business and product development. He joined Hamilton Lane in 1998 from Stone Pine Asset Management.

What type of investments do you look for?
‘We are predominantly buy-out players. Our exposure right now is between 60 and 70 per cent of our total commitments. We invest in all the sub-strategies of buy-outs from large buy-outs through to mid-market acquisition funds through to some funds at the smaller end. Around 12 per cent of our commitments are in venture and the balance is in special situation funds, we do some real estate investing on behalf of a small number of our clients, and we are also investors in secondaries - both via funds and directly. In addition, we make direct investments through co-investment opportunities.

‘Geographically, we have a little over 70 per cent in the US, around 25 per cent in the UK and Europe and a small percentage in Asia. Our European commitments have been increasing recently. Of the $6bn we committed last year, $2.5bn went to Europe. It wouldn't surprise me to see our European investments exceed 30 per cent of our total commitments over the next few years.

‘The portfolio construction varies according to our clients' needs. So our European investors tend to have around 60:40 US to Europe, whereas our US clients tend to have around 75:25 US to Europe. Our Asian clients have some Asian exposure and then around 50:50 US to Europe exposure and our Gulf clients roughly the same.'

Why do you think there is more interest in Europe now?
‘We are very intrigued by what is happening in the European market at the moment and we have been since we started committing capital here about six years ago. We think that the returns over the next four or five years will outpace those in the US, but they will be much more volatile. There will be a greater dispersion of returns here in Europe. There are clearly some tremendous opportunities here - predominantly on the buy-out side.

‘Most of our exposure in Europe is pan-European. We don't do a lot of country-specific funds, although we have done some in Scandinavia and in Germany. If we think there are compelling opportunities on a country-specific level, then we will pursue them. But what we have seen is that many of these funds are seeking to raise too much capital for the type of investments they plan to make.

‘On the venture side, we will continue to focus on the US. We don't see a lot of compelling venture opportunities in Europe. There is and will be a lot of blood on the streets and we would like to wait until all that clears up. There are a large number of players - and this goes for the US, too - that will not be in this market in two years' time. We think that it is best to wait this one out. We will continue our exposure through some of the better known US groups, most of whom are either east or west coast-based.'

How do you find out about good investment opportunities?
‘Our footprint in the market means that a lot of people find us. However, we have an ongoing and proactive dialogue with general partners in the marketplace. We monitor about 1,100 general partner groups on behalf of our clients. That equates to around $700bn to $800bn worth of private equity funds. So we have a deep database of the strategies that we are most keen to invest in.

‘We have a very good sense of who will be coming to market over the next two or three years because we have a forward calendar of funds. That means that, while we may see a fund that looks like a very good opportunity now, it may not be as good for us as something that is coming out in maybe six or 12 months from now. There are times that we will pass on what is coming to market today so that we can focus on funds that we know will be out later on.'

What do you look for in a private equity manager?
‘There are the qualitative and the quantitative sides. We feel the performance numbers shown are not always accurate and as a result, we do recast track records when appropriate. We do go very thoroughly through each portfolio company holding when we do our due diligence and we dig deeply there because our backgrounds are from the direct investing side. We can get into the underlying portfolio companies that the general partners have invested in so that we can form a view in our own minds as to how the investments have performed. The realised transactions are easy to verify. It's the unrealised transactions that we pay a lot of attention to. What are their cash flows? What multiples are being applied? How accurate are the valuations?

‘On the qualitative side, we pay an enormous amount of attention not only to the capabilities of the general partners, but also to the middle management and those people who are responsible for monitoring the existing portfolio. We look at the compensation schemes, the staff turnover, a firm's ability to retain quality people We spend a lot of time with general partners, in their offices, reviewing their operations and meeting the people.

‘There are times when our analysis of a given general partner group and our review of their underlying portfolio companies and their valuations will differ from those presented by the fund managers. It doesn't happen a lot, but it does happen. Some people are just very aggressive - and they are more aggressive when they are in the market. But this is an important issue to us. We are all grown-ups, after all, and we'd just like to see realistic and consistent valuation methodologies being used. There are times - and I'm sure this happens to most limited partners - when two or more funds that we have invested in will have made investments in the same company and in the same security. Often you will find that each fund values that investment differently. That is extremely annoying. It's not pervasive throughout the industry, it's just that there is a modest percentage of the general partners who are just very aggressive in their methodology.'

What makes you different?
‘Our process and our flexibility. By that I mean the thoroughness of our due diligence. That is largely a product of our direct investment experience. We can get very heavily into portfolio companies. It has always surprised me that some advisers and funds of funds have never made a direct investment and yet they are passing judgment on those people that do make direct investments. How can they possibly know?

‘Over time, there will be a weeding out of those. Just as you will see a consolidation on the venture side, you will also see a consolidation on the fund of funds side.

‘And on flexibility, we have 20 funds of funds that most people have never heard of. Only five of those are co-mingled vehicles. The others are single-client funds of funds in which the portfolio construction is designed to meet the specific needs of that client. That side of our business is growing quite rapidly. That is partly because some institutions in 1999 and 2000 thought that they could do private equity investing on their own. As their portfolios have deteriorated, they have found that they need assistance. Times of trouble tend to be very robust times for groups like Hamilton Lane. We can help people who didn't get into the better quality funds or didn't even see them or know they existed. There are new investors dipping their toe in the water and there are some more established investors who didn't maintain their own investment discipline and got caught up in the excitement of the venture arena.'

What advice would you offer to an investor new to private equity?
‘My advice would to be to ensure that their portfolio construction is be designed so as to have the highest probability of generating the types of returns that they are seeking. Be realistic about this. Don't expect the asset class to generate 30-plus per cent returns, for example. That's a big thing. There is not an offering memorandum that we see that doesn't say that the fund expects to generate 25 to 30 per cent returns. It would be interesting when someone finally comes out with a statement saying that they expect to generate a return of 600 or 700 basis points over an index.

‘You have to be realistic in your approach. If an institution has a limited number of staff to dedicate to private equity, that's when a fund of funds or an adviser or both should be considered.'

What irritates you about private equity?
‘Overly aggressive groups irritate me. There are certain funds that overstate their capabilities or their performance. We prefer groups that have managed capital through a variety of economic cycles. For many that are in the market right now, this is the first down market that they have ever seen. We have an extraordinarily large number of portfolio companies that are in the pipeline to be harvested this year. These are companies with stable cash flows that could be taken public or sold to strategic purchasers. On our co-investment side, we have seen a number of companies exit over the last five months. That is very encouraging. But it also means that we know who is doing well and who isn't. We monitor our groups to see what they are doing to rectify a difficult situation and we keep track of those people who are disciplined enough to call it a day on an investment. You can't waste your time and energy on something that isn't going to be successful.

‘The other thing is strategy deviation. Those funds that didn't stick to what they knew are now having problems. That's not just in the venture space but in buy-outs as well.'

What is the biggest issue in the private equity market?
‘I think one of the biggest issues is returns. Limited and general partners must be realistic about their return expectations. That's limited partner knowledge, that's due diligence and it also goes back to the marketing side with the GPs. There are times when a ten per cent return is great; there are times when a 15 per cent return is poor. You just have to be realistic about your expectations.'

How do you think that the market will change in the future?
‘There will certainly be consolidation. So there will be pain, but if you look at the history of this asset class, the investments made in soft economic conditions typically generate the better returns. Seller expectations have declined, it has been slow from an investment perspective because discipline has crept back into the market. Valuations are now much more fair for both buyers and sellers. There are some very bright general partners who kept their powder dry for this downturn. They will reap the benefits.

‘Investor expectations will become more realistic. That applies to both the public and the private markets. You will also see fewer general partners, but this means that the process is going to be ever-more important. As an investor, you need to determine which general partner, in a given strategy, in a given geographic area is best suited to achieve superior rates of return on a risk-adjusted basis. The process through which you arrive at the answer has always been important, but it will become increasingly so in the future.'

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