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Institutional investor profile: Peter Hielscher, Head of Private Equity, Gerling Insurance

Hielscher on the difficulties of co-investing, on the lack of comparable performance information in the industry, on private equity's fall from grace in Germany and on why things could still take a turn for the worse.

Established in 1904 Gerling is a German insurance company with offices around the world. It started its private equity fund investment programme in 1997 and has since built up a portfolio of commitments valued at E380m, which represents an allocation of a little under one per cent. It initially invested via funds of funds, but now invests primarily in venture capital, buy-out and secondary funds in the US and Western Europe. Hielscher joined Gerling in December 2000 and was previously consultant for companies in turnaround situations.

Why do you invest in private equity?
‘Our decision to invest in private equity was driven by the potential for high returns.'

What type of investments do you look for?
‘We have a diversified portfolio made up of investments in the US and Western Europe across a broad spectrum of sectors. We have between 75 per cent and 80 per cent committed to buy-out funds, with the rest in venture capital.

‘When we first started investing in private equity, we invested via funds of funds to get a good level of diversification relatively quickly, to get us through the learning curve and to help us build networks of contacts. But we now invest directly with the funds themselves for the most part because we want to avoid the double dip of management fees and we feel sufficiently well connected to source funds for ourselves.

‘We do, however, invest in secondaries funds - we have committed to two so far. We have been pleased with the results we have seen from these investments. There are currently a lot of opportunities in the secondaries market.'

Do you make co-investments?
‘We don't make co-investments any more. We used to do them in the past, but stopped about a year and a half ago. We did this for two reasons. The first of these was that we came to the conclusion that you cannot make fund and direct investments successfully with a small team. Direct investments are too time-intensive and they require a totally different due diligence process. I think you either have to choose which type of investments you want to make - fund or direct - or you have to establish a separate team that is dedicated to direct investments. The second reason was the results we had from our co-investments. They were very poor.'

What size investment do you tend to make?
‘Our usual investment range is somewhere around the E10m mark, but we have made commitments of up to E30m and some have been smaller than E10m. It really depends on the size of the fund.'

What is your expected future allocation?
‘We are currently not looking to increase our allocation from its current level of just below one per cent. In fact, we are unlikely to be investing any more capital this year. This is a reflection more of external factors than private equity performance. We have not been immune to the difficulties faced by German insurance companies and the downturn in the public market. We are also affected by the ruling by BaFin, the German supervisory authority, which states that German insurance companies can only invest in private equity if they can prove that they have the expertise to do so. In addition to all this, our credit rating affects the management's willingness to look more at private equity. As with many German institutions at the moment, our management are taking a cautious approach.

‘I would like to invest more in private equity, but at the moment that isn't practical. The situation may change for insurance companies at some point in the future, when their balance sheets are looking healthier and the Dax is back to 3,000. But that won't happen immediately.'

Which areas do you think are particularly promising at the moment?
‘We take the view that it isn't helpful to identify particular sectors or countries. To do that, you have to be convinced that a particular industry or type of investment is going to bear fruit three to seven years from now. I don't think that is possible. Anything can happen between the time that you commit and the time that the money is invested and then exited. You have to take a diversified approach. We don't avoid particular areas and at the same time, we don't over-invest in others. We want to balance risk as much as possible. We also seek to invest every year - you never know which are going to be the good and bad vintage years.'

What is the biggest mistake that you have ever made?
‘I would say that our biggest mistake was doing direct investments. In retrospect, we started late when the markets had been over-hyped. We didn't make many direct investments, but they all failed.'

What irritates you about private equity?
‘I get irritated by the fact that the industry still hasn't managed to achieve a satisfactory level of transparency for investors. We are simply not able to compare data from different firms. The European Private Equity and Venture Capital Association has now been in existence for 20 years and we have the BVK in Germany. Some efforts have been made to provide reporting guidelines, but they do not go far enough. Why can't there be a single, standard form that GPs fill in to provide performance information that is all calculated in the same way? The way it currently functions creates a lot work for both sides. GPs have to provide the data in different formats to cater for different investors' needs. Even then, the investor never really gets what it needs and has to do additional work to recalculate all the numbers to fit their models. So in the end, both sides have to hire entire teams just to deal with reporting. It's so inefficient and it's very frustrating. We are a small team and it's one of the main areas that we struggle with.

‘There has to be some way to standardise this. We all need the same information in the end. I know that EVCA is working towards this, but it is still some way off. I do, however, think that this is more likely to come out of Europe than the US. Our industry is much younger than that in the US and can therefore learn from the experience gained over the Atlantic. It's also more likely to come to fruition here because EVCA is making a determined effort to achieve this - there is no equivalent body in the US. The NVCA has so far appeared to be reluctant to take a lead in this.

‘Either way, we have to be able to find some means of evaluating fund performance on a consistent basis rather than being misled by the kind of information that we currently receive.'

What is the biggest issue in the market?
‘I see the biggest issue - from a German investor's perspective - as being the downturn in all markets, including in private equity. This has hit the insurance industry at a time when everything else went wrong. I think these factors put a question mark over the future of the private equity industry in Germany. It was relatively young when the crash happened, it hadn't quite been through the J-curve and so people hadn't yet started seeing profit. Most of the people in Germany only really started investing in 1997 and 1998 and so, under more normal circumstances, they should have started seeing distributions by now. But in actual fact, we are not just seeing poor returns now - they are disastrous. That has shaken many institutions' confidence in private equity.

‘And I think that it will get even worse. I don't think that all the write-downs on portfolios have been taken yet, especially in venture capital. In venture capital in the German-speaking area, for example, managers have written down around half of the portfolio. The rest have been refinanced over the last year or so and they have struggled to survive, but there is now no new money coming from institutional investors to the venture capital firms and they are running out of money. So even the good companies that have received funding relatively recently are looking as though they will fail.'

How do you think that the market will change?
‘The industry in Europe, apart from that in the UK, is relatively young. But it grew too quickly. I hope that it will start again on a smaller and more professional basis. All the people who piled into private equity during the hype years are now gradually moving away. They came into it because they were greedy rather than because they had any passion for the industry. I would hope that now that things have got tougher, they will go back to whatever they were doing before to leave behind a more professional European private equity industry.

‘I do think that many investors, especially the newer ones, will continue to be sceptical of the industry for some time yet because of their bad past experience. But if it can prove a level of professionalism and, importantly, good returns, I believe that many of them can be convinced to come back into the market.'

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