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Institutional investor profile: Brian Stewart, Managing Director, Private Markets, University of Toronto Asset Management Corporation

Stewart on the importance of partnership in private equity investing, on why now is a good time to be in the asset class, on the publication of IRRs and on why mergers between firms will not improve the market.

The University of Toronto Asset Management Corporation was formed in May 2000 to manage the assets of the University of Toronto pension fund and endowment. UTAM has five per cent of its total assets allocated to private equity from the pension fund and ten per cent from the endowment. It invests in North America and Western Europe in venture capital and smaller buy-out funds and has also been active in the secondaries market. Stewart joined UTAM in December 2000 and was previously at British Columbia Investment Management Corporation where he was latterly Vice President, Private Markets.

Why do you invest in private equity?
‘The main reason for UTAM to invest in private equity is to generate superior returns. We expect to achieve returns of around 500 basis points over public markets in our private equity investments over the long term. We also invest for increased diversification. By committing to private equity, we can gain access to areas and sectors of the economy that we wouldn't otherwise be able to access.'

What type of investments do you look for?
‘We are a relatively small investor and so we don't write big-tickets. We have taken an opportunistic approach based on what we believe to be the most interesting areas and funds. We are probably the first investor in Canada, for example, to have invested in a timber fund. We have invested a fair amount in venture capital and some in smaller buy-out funds. An example of one of our investments is HealthCap, a European life sciences fund. We have also been very active in buying secondary positions in funds.

‘We are less keen, though, on the larger funds. Not that there is anything particularly wrong with them, it's just that they need large amounts of leverage to be successful and I don't see banks providing leverage now. I don't think the returns are going to be great. We also actively avoid sponsored funds. I have never been comfortable that there is sufficient alignment of interest with this type of fund.

‘We are working on a co-investment at the moment, but generally, we tend not to do these. This particular case is a special situation and it is the first time we have ever made a co-investment - it could well be the last. The reason we are doing this one is because it is in conjunction with a fund we know very well and we feel that it is a great opportunity for us to get into a project, in this case in the energy sector, really at greenfield level. For a fund such as ours, that is a fairly unique occurrence.

‘We have a stronger bias towards North America than any other region, but that is a function of the fact that the market is larger than any other. But we are opportunistic in that respect. If we see better opportunities in Europe, then we'll invest there rather than the US.

‘We take a mainly bottom-up approach to private equity investing. We are not overly concerned if we are slightly long in a particular sector over the short term. That's not to say that the top-down approach is not relevant. That comes in when we are thinking about the overall portfolio over the longer term. We would like to see a well diversified and balanced portfolio over, say, a four-year period.'

What is your appetite for first-time funds?
‘We currently have a prohibition on investing in first-time funds because the programme is so new. That may be subject to change in the future - or at least I hope it will be.'

How do you expect your allocation to private equity to change in the future?
‘We currently have five per cent of the pension fund assets and ten per cent of the endowment committed to private equity. We are close to that on a committed basis now. I would expect those percentages to increase over the longer term, but I don't expect any changes in the short term.'

How does your investment process work?
‘We source opportunities in a couple of ways: one of these is through placement agents and taking direct calls from funds; but we also look actively for opportunities in particular areas. Before investing in the HealthCap fund, for example, we identified life sciences as being a sector that we were interested in for various reasons. We then did a search for the best managers in that space. We looked at about 80 and were able to compare the funds in the same sector to work out which we felt were the best placed to achieve excellent returns. We take the same approach if we are contacted by a placement agent or directly. We feel that it is very important to look around and see who else is in that space to gauge whether the area is a promising one and which team we feel will be the best fund for us.'

What do you look for in a fund manager?
‘We look for teams with a verifiable track record, a deep understanding of the sector that they are in, an undeniable comfort level with the team. I look at all of these deals as partnerships that last for ten years - once I have signed the terms, I don't ever want cause to have to look at the partnership agreement again. To ensure that is the case, I have to have full confidence in my partners. I want them to look at me as a partner, too. So, at the end of the day, it comes down to people, people, people. Obviously, we look at sectors, but even within those sectors there are a lot of players to choose from. As a result, you have to make judgments that go beyond the numbers and look very much at the intangibles.

What advice would you offer to an investor who is new to private equity?
‘I would advise an investor to ensure that everyone in his investment team understands that private equity is a long-term investment and that the commitment is therefore long-term. They need to understand the J-curve effect rather than focusing on the quarterly numbers. To be successful, investors must give the private equity process time to work.

‘Talk to as many people as you can. Build up a good network of people who understand private equity well, including other investors. Bounce ideas off those people. New investors should definitely consider starting off by investing via a fund of funds to get a good level of diversification in the private equity portfolio from the outset. But choose your fund of funds carefully. Make sure they will readily share information with you, that they will be available to help you through the learning curve and talk through any ideas you may have.

‘But I would still advise people to get into private equity - now more than two years ago. While you can't time the private equity market, there are evidently some great opportunities for investors right now. Asset prices have come down and the hysteria has gone out of the market. It's a much more healthy environment than it was back in 2000. I'm not sure that many investors would take that advice, but then, that's what is great about today's opportunities - the fact that not everyone is piling into private equity means that those that do invest in the asset class will recognise kind of returns that private equity is capable of generating.'

What is your view on the publication of IRRs?
‘I am in two minds about this issue. The pensioners of a pension fund have every right to know how their money is being invested and how it is performing. But equally, I do not think that private equity fund performance information such as individual IRRs is public information. I have no problem with plan holders having that information, but I don't see why it should be available for other investors and competitors on a public web site. I also do not see why it has to be real-time information. Typically, we get our information quarterly in arrears and we report every six months to the plan in arrears - that is the most that anyone should expect. This means that anything that is commercially sensitive is protected.

‘Over the longer term, I think that we'll see that some of the larger plans being forced to disclose this information start to lose out. They will lose the access they currently have to some of the funds that they'd like to commit to. But on the other hand, I think that general partners will be forced to change the way that they report. It will be one step forward on both sides, but two steps back.'

What is the biggest mistake that you have ever made?
‘I think that my biggest mistake was picking a group that I wasn't confident with on a personal level. The chemistry just wasn't right and it turned out to be absolutely the wrong firm to be with. At the time I made my decision, everything looked good. I didn't particularly like the guys, but I decided that it was too good an opportunity to pass up. I was wrong and I have learned from that.'

What is the biggest issue in the market?
‘Confidence. That's the biggest issue at the moment. In 2000 the issue was probably confidence, too, in that people had way too much of it. These days it's the opposite. Although firms are saying that it's a great time to invest, you are not seeing them investing. But I think that things just need to settle down and that people need to understand that private equity is a long-term investment. We're building businesses; we're not creating IPOs. Building a business takes time - especially in an environment such as today's.'

How do you think that the market will change in the future?
‘I have heard people talk a lot about consolidation. If by that they mean that larger firms will swallow smaller firms, then I don't think that is a good thing. I hope that doesn't happen. I do expect the market to shrink substantially, though. And if second-tier, third-tier, etc managers disappear, that's no bad thing. What I don't see is the benefit of adding a third-tier manager to a top-tier fund in some kind of merger. That's not going to help matters much - I think these firms should rather disappear.

‘So, in the future, I think that there will be fewer managers and fewer investors, too, as people get out of the asset class. If that happens, it should bring the market back into some kind of alignment with where it should be.'

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