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Institutional investor profile: Helen Steers, Managing Director, Private Equity Europe, Russell

Steers on why private equity will continue to outperform other asset classes, on firms manipulating their track records, on whether private equity is a scaleable business and on how it can become a mainstream asset class in Europe.

Russell, one of the largest global multi-manager firms, offers its clients a diversified portfolio of investments across every asset class and has a specialist alternative investment division, which includes private equity. The firm has researched private equity managers for a number of years and set up a fund of funds programme towards the end of 1997, which includes co-mingled funds, customised separate accounts and private label funds of funds. Russell invests across the private equity spectrum in the US, Europe and Asia. Steers joined Russell in 1999 and was previously responsible for managing a C$1bn portfolio of private equity investments for Caisse de Dépôt et Placement du Québec.

What type of investments do you look for?
‘We invest across the private equity spectrum and right across the globe. We have offices in the US, Western Europe and in Asia. Our aim is to build a long-term, well diversified portfolio for our clients across all regions and sectors, rather than chasing specific hot spots. We look for the best of breed in each of the different sub-sectors. In Europe, for example, we try and find the best pan-European fund, then in the individual countries, we look for what we consider to be the best country-specific funds. Having said that, if we don't find what we're looking for in a particular market, we simply don't invest - we don't set rigid allocations for particular markets.

‘Our approach to constructing portfolios is very much a combination of top down and bottom up, the make-up of which is dependent on our clients' needs. But if I give our generalised global private equity fund of funds programme as an example, you would find around 50 per cent allocated to the US, 40 per cent to Europe and ten per cent to the rest of the world. We take the same approach for the different types of private equity - mezzanine versus buy-out, versus venture, distressed, secondaries, etc. Once we have these frameworks in place, we build the portfolio from the bottom up. But within that general framework, we could be quite flexible and invest say, between 45 and 55 per cent in the US, or if we found a particularly good mid-market European buy-out manager and yet we had reached our allocation for this area, we would still consider adding it to our portfolio.

‘I don't think that you can have hard and fast allocations in private equity. If you think about the typical investment period for a fund of funds, which is between three and five years, you have to be flexible because you simply can't predict accurately which opportunities will present themselves when you close your fund.'

What about co-investments?
‘We are able to make co-investments. A number of people on our team have direct investment experience and co-investment expertise - myself included. But we do not focus on co-investments, unlike some of our competitors. No more than ten per cent of a total fund would go into co-investments, unless one of our special account clients requested us to invest more on their behalf.

‘We view co-investments primarily as a way of enhancing our overall returns. But we also like to be able to take advantage of some of the interesting deals in the market and it is a differentiator for us because we do have a significant amount of experience in this area.'

How else do you differentiate yourselves from other players in the market?
‘One of our key differentiators is that we are one of a handful of truly global players. We have expertise across the world and that global reach is complemented by local access because we have strong teams on the ground in all the major markets. In Europe, for example, we have a main office in Paris to tap the continental European market - that's an area that we believe has a strong potential for growth over the coming years.

‘Russell is also a specialist in manager selection. That is our bread and butter and has been for a long time. That focus means that we are good at picking the best managers.

‘Another big differentiator is the fact that we are willing to work very closely with certain large investors. We are able to manage bespoke programmes. That, allied to the efforts we put into research, education and information for investors, mean that we are able to service our clients according to their needs.'

What do you look for in a fund manager?
‘Our investment process is very disciplined and is partly driven by our public markets investment expertise. We apply a ratings system to all the opportunities we see. Then on top of that, we combine all the best practices of the private equity industry.

‘We have put together a set of five key criteria, under which we have another sub-set of criteria. The main ones are: people, process, philosophy, performance, fit. Each of these has a weighting, although I wouldn't say that any one had a greater significance than any other. Some managers will be stronger on the people side, for example, and others on the performance side.'

What puts you off investing in a fund?
‘One of the biggest deal killers is the manipulation of track records. A certain amount of that always goes on, but we do see very blatant cases - I don't know who they think they are kidding. We also won't invest in a fund if we feel that there is not enough principal investment experience, such as a true first-time fund in which the partners have not invested in private equity before.

‘We also do not invest in very small funds - $100m is pretty much our lower limit. This is partly because we feel that if they are managing a very small amount, it is unlikely that the manager is going to be of institutional quality and they will not get through our investment process successfully. We also do not want to take any more than a ten per cent stake in any partnership. So it's partly a quality and partly a practical rationale.'

What is the biggest mistake that you have ever made?
‘The biggest mistake that I have ever made is from my direct investing days. It's going back a bit, but I invested in a company in Canada that had the most fantastic technology - the best that money could develop - believing that that would be enough to make it a huge success. It was run by a very talented engineer, too. Unfortunately, the product didn't sell adequately enough. As is so often the case with venture capital, a company with an amazing product produced by highly skilled experts is not always enough to make it successful. Sometimes these products are over-engineered and too good for the market, as in this case, or there is simply no market for them because they are ahead of their time. I learned a great deal from that.'

What is the biggest issue in the market?
‘Private equity is evolving as an asset class. If you look back, particularly in the US, foreign equities used to be a non-traditional asset class. Nowadays, they are part of the mainstream. There is no reason why private equity won't become more traditional, too. It's happening in the US already and it should happen in Europe in the future. But before we get there, there is a great need for more education among investors and that is a big issue. Pension fund trustees, for example, need to understand private equity better and they need to understand the dynamics - it is not about making a fast buck, you don't get your money back in two years.

‘Some industry associations are doing a good job of promoting the industry, helping with the educative process and working on the issue of reporting and transparency. All this is moving the industry in the right direction. It is becoming more professional and better understood by investors and as a result, is becoming part of the fabric of business and investment. You only have to open the Financial Times to see this. Almost every day now there is a story in the main part of the paper that is linked in some way to private equity. It has entered business vocabulary. That is a huge difference from five or ten years ago.

‘This coming of age of the industry in Europe also creates another issue. This has already come to the fore in the US. Funds have been increasing in size, many are facing succession issues and there are large numbers of spin-offs. That has to be managed properly. Managers that have raised ever-larger funds have to ask themselves where they are going. Are they going to institutionalise their businesses?'

Do you think that private equity can be institutionalised?
‘There are a number of groups that are trying to do that, but it's not clear yet whether it is possible to run a private equity firm on a very large scale.

‘The larger a firm becomes, the more it has to think about the way in which it is managed. You don't manage a firm of 100 investment professionals in the same way that you manage a firm of six or seven. You don't have the same processes and the investment strategy is very likely to have to change. It is as yet unproven whether private equity firms are able to make this transition.'

How do you think that the market will change in the future?
‘I think that the market will continue in its evolution. More and more institutions in the US are investing in private equity and we will see the same in Europe. Investors are looking for good returns. We are moving into a low inflation, low interest rate, low return environment and so people are looking to try and get Alpha. Private equity is probably the ultimate active management strategy.'

If it has yet to be proven that private equity is scaleable, how will that inflow of capital affect the market?
‘As more money comes into the asset class, firms that are more professional and better organised are likely to benefit. But I don't subscribe to the argument that an increase in capital will affect performance relative to other asset classes. Private equity will continue to outperform public equities. Private equity investors benefit from certain structural characteristics of private equity, such as the inefficiency of the market, and the fact that fund managers are actively involved with their companies and can access a level of information that is not available to a quoted equity manager. There is also an alignment of interest between portfolio company managers and their investors which helps to drive returns. Finally, investors are compensated for the lack of liquidity and long investment time horizon in private equity.

‘So I believe that you will continue to see that outperformance, but within that there will always be a huge dispersion of returns. You will still see extremely good, experienced managers way outperform the market and you will see managers that come out too late in the wrong sector or with the wrong strategy and they will perform very badly. I think there may even be greater dispersion of returns than we see today. The key to success will be manager selection.'

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