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Institutional investor profile: Anders Stromblad, Head of Alternative Investments, Second Swedish National Pension Fund - AP2

Stromblad on taking a step-by-step approach to private equity, on why private equity is challenging for investors, on the importance of finding good managers and on the value of investing with teams with a broad mix of skills.

Based in Gothenburg, AP2 is one of Sweden's four of new national ‘buffer' pension funds. It was created in January 2001 as part of an overhaul of the nation's pension provision and currently manages in the region of E14bn. The fund has so far committed approximately E80m to private equity funds, but is able to increase its allocation to five per cent. It has invested in Scandinavian funds to date, but intends to invest across all stages, vintages and sectors in the US and Europe. Stromblad joined AP2 in 2000 and was previously CFO at Swedish Meats.

Why do you invest in private equity?
‘Our main objective for investing in private equity, and more broadly to alternative assets, is firstly to give us increased diversification to our overall portfolio and secondly to boost our overall returns. We see private equity as a diversifier in terms of asset class, so we are diversifying away from bonds or real estate, for example. Our absolute returns expectation for our entire alternative assets portfolio is 11 per cent.'

How much do you expect to allocate to private equity over the long term?
‘So far, we have made only a few private equity commitments. We have decided to commit to the asset class very gradually. We don't think that you can time the market in private equity. To be successful, we believe that you have to invest consistently over a sustained period of time. We have so far invested E80m in private equity funds, but we think that we will be quite a substantial investor in the asset class.

‘We have a legal limit on the amount that we can invest in unlisted securities of five per cent of the overall portfolio. If we ever reach that limit, it will be after having taken a step-by-step approach to investing. Our investment level depends on both the top-down macro conditions and on the availability of excellent managers - the bottom-up analysis. We are not in a hurry to reach five per cent, but we do have ambitions to be a considerable private equity investor.'

What type of investments do you look for?
‘The type of investments that we look for is very much dependent on our strategy - our step-by-step approach to building the portfolio. The most important part of this strategy is diversification by time, geography, sector and stage. The next factor in our strategy is that we believe that we should be highly selective about which funds we commit to. We don't think that it is sufficient to allocate to the asset class generally; we believe that the only way to achieve superior returns is by finding the best managers. As a result, we have spent a lot of time building up a wide network in the industry to ensure that we are seeing all the funds that we possibly can and then select what we believe are the best opportunities in a given space.

‘So, we have started by looking at and investing in funds that are closest to us geographically. We felt that this was the best and most efficient way of getting to know the business. Over the last two years, we have met with a large number of funds - over 50 of them - with a Scandinavian base and created a good dialogue with them. We have made investments in some of those funds and there are some on which we are currently conducting due diligence.

‘Our next step is to widen the net to fulfil our investment strategy. We are just starting to look more internationally now that we have a good base of investments in Scandinavian funds. To achieve our aim of diversification, we are looking at investing in funds of funds - initially, at least - so that we gain a good coverage of the main markets in the US and Europe. The idea is that we would like to start with a core of well diversified funds of funds. Once we have built up exposure to these, we may then consider committing to more specialised funds, such as funds of funds with a narrow strategy, such as US venture or European mid-market buy-out. This isn't set in stone. It is an idea we are exploring at the moment.'

Do you make any direct investments?
‘We do not make any direct investments - we are prevented by law from investing directly in unquoted companies.'

What is your appetite for first-time funds?
‘We take the view that if you are building a diversified portfo,io, you will end up investing in some emerging managers - they are part of the overall universe. We do not have a philosophical stance about first-time funds as some investors do. There will always be new and spin-out teams appearing on the market and some of these will be extremely good funds. We don't want to miss out on them.'

What do you look for in a private equity fund manager?
‘There are a number of things on which we place great importance when we are examining a fund investment. The most significant of these is the people. We need to feel comfortable with the managers, in terms of our rapport with them and in terms our confidence in their ability and experience - we believe that there should be a good mix of skills and experience in a team.

‘The second thing that we look at is the firm's strategy. We need to be sure that it has followed its stated strategy consistently and that the investment style is realistic going forward.

‘We look at the firm's track record. The Scandinavian funds that have raised money in the past have had a reasonably successful history compared with those in some other European regions. But, bearing in mind the events of the last few years, we spend a lot of time looking at and discussing the valuations of the fund's portfolio companies. How realistic are they? How have the firms arrived at those valuations? We also need to be clear about a firm's resources and what it might need to work with their portfolio companies, especially in those firms that still have a large number of unrealised deals in their previous funds. Problem investments always take up more time than you ever imagine they might.

‘What we also like to see is that a team adds value to their portfolio companies. We like teams that are active owners of their investments and take time to improve the business. We do not believe that financial engineering and multiple expansion will achieve the returns that we would like to see. So we like to see teams that have financial experience plus management and operational experience. I think teams are beginning to take this on board. Back in the early 1990s, there were very few teams with this mix of skills. Nowadays, I think you're seeing more of these.'

Which areas do you think are the most promising?
‘We take a view on the macro-economic conditions in different markets, but we think that it is very dangerous to focus on one or two areas because you think that they are particularly hot. As a result, we don't really look at private equity in terms of the most promising areas.'

As a relatively new investor, what aspects of private equity have you found to be most challenging?
‘I think that private equity overall is a challenging asset class for investors. Unlike some other asset classes, you really need specialist knowledge and a large network of contacts to ensure that you are successful. This is not a passive investment. You can't just commit to a few funds and then sit back and wait for the money to come rolling in. You have to monitor those investments very closely. You have to ensure that the fund managers know that you are monitoring them closely, too, because that can really make a difference to their approach.

‘One of the more challenging aspects about private equity, especially as a new investor, is to invest gradually and not be swayed by current events. You have to take the long-term view and find funds that you are very confident will produce the returns that you are targeting. You also have to find funds that fit your overall asset allocation targets. After all, private equity is just a small part of a very large fund.

‘I think one of the most valuable things about the way that we have set up our process is that we use the experience and skills of a wide variety of our in-house team at AP2. It's a people business. You are relying more on the people managing the fund than you are in other asset classes. Choosing the right team is key. You are backing them for ten to 12 years and so you have to be good at judging people. I am the only person with day-to-day responsibility for private equity investments, but the fact that our investment committee includes people from many different areas of AP2 means that they can bring their specific knowledge and judgment to the mix - it's important not to make these decisions entirely on your own. I am also able to draw on the experience of our sector specialists if I am looking at a sector-specific fund. I try to use in-house expertise where I can. We have a very open organisation and that helps a lot.'

What is the biggest issue in the market at the moment?
‘You can't look at private equity in isolation from the macro-economic situation - and that is an issue at the moment. It is the driver behind all business in terms of growth and mergers and acquisitions and the ability of private equity firms to exit. Things are not looking good now. But I think that there is always a place for good private equity managers. Good managers are always able to add value to their portfolio companies. They are always able to buy well and they are able to sell, even in when the macro-economic situation is far from optimal. I think that the downturn we are seeing will really highlight which of the managers have made good investments between, say 2000 and 2003, and then made the best of them. On the whole, I believe that good managers will always be able to spot and exploit opportunities no matter how difficult the economic environment. I think that is more true of private equity than most other types of investment.'

How do you think that the market will change in the future?
‘I think that we will see a continued shift towards more balanced teams that rely not solely on financial skills, but also add operational experience into the mix. So we will end up with funds with a much broader knowledge and skills base.

‘I also think that the internationalisation of funds will continue. We have already seen the development of large pan-European players, for example, which have emerged from firms concentrating on one country. We will see more of these and we will see more international firms that operate in a number of continents but that will have local presence in particular countries.

‘At the same time, we'll also see an increasing specialisation of funds. You already see funds that specialise in life sciences investments, for example, but I think that as other types of firm attempt to differentiate themselves from their competition, they will narrow their focus.

‘These are the three key trends for the coming few years. And, as a result of these, the market will mature. It will also become much more apparent to investors which funds are the market leaders in their chosen strategy.'

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