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Institutional investor profile: John Greenwood and Stuart Waugh, Managing Directors, TD Capital

Greenwood and Waugh on wanting to be an investor of choice, on the untapped pool of Canadian capital, on the effect of the capital overhang on the industry and on the opportunity for newer markets to change private equity investment patterns.

Based in Toronto, TD Capital has been investing in private equity since the late 1960s. Historically, the capital for its investments has come from its parent organisation, TD Bank Financial Group. Since 1999, TD Capital has started raising third-party money, primarily from Canadian institutions, including TD Capital's first private equity fund of funds, which recently closed with commitments totalling US$333m. TD Capital currently has approximately C$3bn of capital under management. TD Capital Private Equity Investors invests primarily in North America and Europe, and also seeks opportunities to purchase secondary interests in private equity funds. Greenwood joined the firm in 1996 from the position of partner at the Canadian Mezzanine Fund. Waugh has been with TD Capital since 2002 and was previously a management consultant at McKinsey & Co, specialising in corporate finance and asset management for institutions.

John Greenwood	Stuart Waugh

What type of investments do you look for?
John Greenwood: ‘Most of our investors are first-timers in private equity and pretty much all of them have never invested in private equity outside of Canada. We're looking to put together a very broadly diversified portfolio for our investors. So we want to give them exposure across the board - from large to small buy-outs and from seed through to later stage venture capital - in the most developed private equity markets ie, North America and Western Europe.

‘The strategy for our fund of funds therefore is to invest 70 per cent in North America and 30 per cent in Western Europe. We are also seeking to diversify our portfolio according to investment style, so we'll be investing 60 per cent in buy-out funds and 40 per cent in venture capital funds.

‘We have also targeted around ten per cent of the capital for secondary investments. We take a slightly different approach from most other investors. We approach secondaries with the view that we are attempting to establish a relationship with groups that we would like to invest with in future. So, it's a far less opportunistic and much more structured approach.'

Was it your intention to target novice private equity investors in your fundraising?
JG: ‘We decided to raise a fund of funds after raising external money for a buy-out fund that focused purely on Canadian opportunities. When we were fundraising, we found that there were a few large, sophisticated investors in Canada who were actively seeking managers, but we were surprised by the number of mid-sized institutions who were interested in private equity and yet didn't have a vehicle through which they could gain reasonable exposure. So we decided to create one for them.'

How many investments do you anticipate making over the next 12 months?
JG: ‘We were fortunate enough to be able to use capital from TD's balance sheet while we were out fundraising for our fund of funds. TD contributed US$150m of the total US$333m that we raised. So we were able to commit some of that money. We are now looking to invest the balance of US$160m over the next 18 months or so.'

How do you find out about good investment prospects?
Stuart Waugh: ‘We use a variety of means to find out about good investment opportunities. The first of these is leveraging existing relationships - those that TD Capital has built up over the last 30 years. Those relationships include the GPs themselves, placement agents and other LPs that we have worked with in the past. That gives us a very solid base from which to start looking. We take a proactive approach and look closely at markets that we are interested in and that fit our portfolio construction targets. From that, we draw up a shortlist of core GPs. It doesn't matter whether they are in the market now or not. Our aim at this stage is to build relationships with them, which we sometimes do, as John mentioned, through investing in a sEcondary position. Once we have established a relationship, we are confident that GPs would come to us next time they are fundraising. We want to be an LP of choice for these funds.'

What do you look for in a private equity manager?
SW: ‘We look at three main factors when we are screening funds. The first of these is strategic fit. Does the fund fit our investment objectives and portfolio construction targets? Second are what we consider to be distinctive GP attributes: track record, investment strategy and process, plus some kind of sustainable competitive advantage. What is it about that GP that has enabled them to outperform in the past and what gives us confidence that they will be able to continue outperforming? That may be the strength of the management team, it may be a particular source of proprietary deal flow, it could be some kind of internal research function or it could be the depth of their industry knowledge. Whatever it is, we need to see something that makes them stand apart from their peers. We also look at the organisational processes and systems. Are these sufficiently robust and set up in such a way that they enable the team to execute their stated strategy? This would include their back office function, their finance department, risk management. What is it that they need to build as part of their asset management franchise to enable them to deliver on their strategy? And then the third key area that we look at is the terms and conditions. Are they standard? Are they consistent with the nature of the strategy?'

JG: ‘One of things that we really strive to distinguish ourselves on is the coherence and discipline of our investment process. Given that we both raise money and invest it, we understand what GPs face when they go out fundraising. We strive to have a process that is not only rigorous, but is also coherent and fact-based and that makes sense to GPs. We try to make a timely, fact-based decision, whether it is yes or no, as opposed to dragging out the process. That is an important feature of what we do and we believe that it helps us in our aim of being an investor of choice.'

How does the fact that you have a direct investment arm sit with GPs in your portfolio?
JG: ‘We haven't found it to be an issue as yet. Our direct investment funds have pretty specific mandates. One of them is a Canada-based buy-out fund, another is a US-focused mezzanine fund and we also have a venture capital group and a communications group. None of these groups has ever competed with the funds that we invest in. They have, however, occasionally co-invested alongside them.'

SW: ‘One thing we do find is that, particularly investing in Europe and the US, GPs have viewed the emergence of what is a kind of one-stop shop for smaller pools of Canadian capital very favourably. We can provide GPs with access to a diversified Canadian pool of capital that they haven't tapped up until now. They see it as an opportunity to deal with one group that has a 30-year track record of participating in the industry and that can allow them access to a group of investors that they, in all likelihood, would otherwise be unableto do business with.'

How do you account for the increased interest in private equity among Canadian investors?
JG: ‘It's much like the situation in Europe. The Canadian institutions were, on the whole, much slower than their US counterparts to embrace private equity as an asset class. We are simply seeing a lag. But we are seeing a marked interest now in private equity in Canada. Our data suggests that the average US institution has around seven or eight per cent of their total assets in private equity; the equivalent figure for Canada would be somewhere between one and two per cent. We believe that there is scope, therefore, for Canadian institutions to increase their allocations quite substantially.'

Which areas do you think are the most promising at the moment?
JG: ‘We are spending a lot of our time right now looking at regional funds across Europe. This is a sector where we haven't historically made very many investments. We are seeing a lot of interesting opportunities now in this type of fund. I think this is a reflection of the growth of the market over the last few years. Funds in Europe have become more specialised and sophisticated than they were in the past.'

What advice would you offer to an investor new to private equity?
SW: ‘We would emphasise two main areas. The first is not to underestimate the resources or the expertise required to be successful in private equity. Commit yourself to building that expertise internally or buying it from outside via a fund of funds before leaping into private equity. Only then will you be able to get the scale, access and the identification and selection of the industry's top performing managers. And only then will you be able to carry out thorough due diligence and effectively monitor your portfolio. If you are not prepared to make that commitment, either through building a team or through an advisory relationship, then you need to reconsider going into private equity at all.

‘The second piece of advice would be to remember that private equity is a truly long-term investment. The trend today is towards day trading in mutual funds and to checking share prices every 15 minutes. Private equity is not an asset class that lends itself to that kind of short-term view. Unless you understand that, private equity is going to be a very frustrating experience for you.

‘We have found that most investors who have commitments to private equity understand both of these points pretty well. But it is only natural when you're investing across other asset classes with a shorter investment horizon and with data available in real time that you need to remind yourself of them every once in a while. The unfortunate thing with some of the recent disclosures is that it has tended to focus some people's attention on short-term performance. Interim data really bears very little relation to the ultimate performance of the asset class over time.'

How do you think that the disclosures made by US public pension plans will affect the industry?
SW: ‘I think that it will encourage debate about the appropriate ways of measuring and reporting performance. People will start to question whether IRR is the right performance measure to use. I hope it will encourage people to think about what the appropriate timeframe is for measuring performance in private equity. It will induce increased transparency and I certainly think that it is appropriate to limit disclosure to fund IRRs rather than drilling down further to portfolio company information. Like any data, it cannot be useful information without context. Otherwise it is simply a set of figures that are open to misinterpretation.'

What is the biggest mistake that you've ever made?
JG: ‘I think that our biggest mistake was to underestimate quite dramatically the length of time it would take us to raise our fund of funds. We knew from our experience of raising the buy-out fund that it would take time, but we had no idea it would be quite such a drawn out process. That partly reflects the fact that many of our investors were new to the asset class and so their processes and structures were not established. It was an education.'

SW: ‘The lengthy fundraising period meant that, despite our ability to warehouse some of our investments with TD Bank capital as we mentioned before, our ability to invest in late 2001 and the whole of 2002 was curtailed. In retrospect, however, that wasn't a bad thing. We can now concentrate on deploying capital in the 2003 and 2004 vintages, which look as though they will offer some very good opportunities.'

What irritates you about private equity?
JG: ‘There's nothing that really irritates me, but one thing I do find a little frustrating is the lack of understanding about private equity among some investors. I think there are a lot of misconceptions about the risk profile of the asset class. But that is simply an opportunity for further education.'

What is the biggest issue in the market?
JG: ‘The biggest issue for us is understanding the impact of the capital overhang in the market, particularly at the venture capital end of the spectrum. There has just been such a dramatic change in the venture industry - and that change will continue to play out over coming years. We feel very comfortable with the venture groups that we have committed to, but there will be a shift. I also think that there could be some good opportunities to invest in some of the groups that will become the new leaders in the venture market.'

How will the market change in the future?
SW: ‘There are a couple of main areas that will change. One is that access to top performers with a sustainable investment style will become even more difficult. We are starting to see that already as some of the fund sizes shrink. That will become more of an issue than it has been. The second is that we will see increased transparency in terms of fund performance. That will be driven not only by the disclosure of the data and moves to standardise reporting but also by the explosion of the secondary market. As people increasingly buy and sell secondary interests in partnerships, there will be a lot more focus on the way that assets are valued.

‘In addition to these, we will continue to see the growth of the new frontiers, be they the emergence of smaller markets in Europe, or the development of markets in Asia. I think that these changes will transform private equity and shift the focus of many investors away from the more traditional markets.'

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