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Institutional Investor Profile: Chris Manser, Head of Alternative Investments, Winterthur Group

Manser on wishful thinking among limited partners, on the lack of discipline among some funds, on incoherent strategies, on the perils of direct investing and on hopes for a pick-up in trade sales.

Based in Winterthur, Switzerland, Winterthur Life & Pensions and Winterthur Insurance are business units of the Credit Suisse Group. Together, they have E95.5bn under management, of which close to one per cent is allocated to private equity. Winterthur made its first private equity fund investments in 1996 and now invests in US and European venture capital and buy-out funds. Manser joined the alternative investments team in 2000 and was previously in the asset/liability management department at Winterthur. Before that, he was at UBS.

Why do you invest in private equity?
‘We decided to invest in private equity for returns. We believed that private equity enabled us to make surplus returns over public equity markets. I think that is still the case. Our reason for being in private equity is to cover part of our long-term equity exposure so that we can pay out these surplus returns to policy holders and shareholders.'

What are your return expectations for private equity?
‘We expect private equity to return around four per cent in the medium term over public equities. The premium is extremely tough to quantify and I would simply say that if we achieve returns much below that level then I'm not sure that we can justify investing in an illiquid asset class such as private equity. You have to have a liquidity premium.'

How do you expect your allocation to private equity to change in the future?
‘Our current target allocation of two per cent for our Swiss accounts is unlikely to change in the medium term. In general, our equity allocations have come down quite substantially. I can't see us extending our private equity allocation under these circumstances.

‘We have an over-commitment strategy for private equity investments and our plan is to continue making commitments based on that strategy.'

What type of investments do you look for?
‘We have a global mandate. Our main activities are in buy-out and venture capital funds. Our venture capital programme is much more focused on the US than other regions because the market there is more developed than elsewhere. Conversely, our buy-out investments are more tilted towards Europe. In figures, our strategy translates into roughly 80/20, US/Europe for venture capital and 60/40, Europe/US for buy-outs. If this deviates slightly, then we are not too worried. Overall, we are attempting to build a diversified portfolio that is pretty evenly allocated between opportunities in the US and European markets. We invest very little outside these regions for now.'

What would it take for you to start investing seriously outside the US and Europe?
‘We really only want to invest in regions that have some kind of maturity in terms of constant deal flow, business activity as well as some transparency, although we recognise that increased transparency tends to eat away at profitability. We are cautious about emerging markets. You can do very well if you find the one group that is able to exploit the opportunities to full effect, but even if you end up with the second best you could lose money. It is also a question of efficiency. We only have a relatively small allocation and it doesn't make sense for us to screen all the managers in the world. We simply don't have time to do that effectively.'

What type of funds are you looking for at the moment?
‘We are looking for disciplined funds. We want to invest with firms that are not raising too large a fund. One problem is that when we find interesting prospects, we are often far from alone in being interested. As a result, many of these groups end up raising too much money. We just don't see enough disciplined mid-market funds.'

How do you source opportunities?
‘We get a lot of deal flow from intermediaries, such as placement agents. But we also source opportunities through our networks and through direct contact with funds. We try to meet as many players in the industry as possible to ensure that we are tracking all the potential funds we can.'

What is your appetite for first-time funds?
‘We look at first-time funds. The fact that a team is raising money for the first time out on their own would not kill the deal for us. But we like to see people who have worked together before. We wouldn't, for example, back a bunch of people who have joined forces and are simply out to raise money. We want to see experience in the area that they are focusing on and we need to see attributable track records.'

How do you assess a fund manager?
‘We take a much more qualitative than quantitative approach to assessing fund managers. The main aspect for us is to work out the fund's value proposition. That is the biggest task when we're assessing a fund. Hand-in-hand with this is our need to see that value proposition reflected in the track record to ensure that the fund has not strayed from its area of expertise.

‘We like to see teams that have a broad base of skills. What those skills are depends on the sector focus of the fund, but generally it is important for them to have industry expertise and for them to be able to show that they can really add value to their portfolio companies in terms of operational and financial improvements. We also look for financial skills. These are obviously important when a fund is investing, but they are equally so when it is exiting an investment.

‘We also look for team stability. This is very important at the moment, especially on the venture capital side. Many groups are facing enormous amounts of stress after the ups and downs of the past three to four years. You have to be very careful and ensure that you really understand the dynamics of the team.'

What puts you off an investment?
‘One thing that puts us off is a lack of coherent strategy - or in some cases a lack of strategy full stop. Another is if the numbers don't stack up or aren't good enough. For us, the quantitative analysis is not the most important part of assessing a fund, so simply showing us good figures is nowhere near sufficient to make us commit.

‘If we believe that a team's skill set is not complete then we will definitely back off. This has become more of an issue over recent times. You can see it clearly with hindsight - there was a lot of tailwind in the late 1990s from the booming stock markets that carried people along. We don't expect there to be this tailwind in the future and so skills count. Leverage is not as freely available as it has been in the past, either. You really have to grow the bottom line to make successful investments. Teams need to know exactly what to do with their portfolio companies to add value.'

How long does your investment process take?
‘Our process varies in length according to the opportunity. Sometimes you have to be very quick; at other times you can take a little longer. Typically, we like to take our time over assessing a fund so that we can see how things progress. We can reach a decision within a month, but more usually, we take three months from start to finish.'

At which stage in the fundraising process do you prefer to commit?
‘It depends on the opportunity. If we are looking at a follow-on investment with a firm we have committed to before, we can re-up fairly early on in the process. With some others, we prefer to wait and see which other investors have committed to the fund in the first close. At other times, you have to be in on the first close because you really don't know whether there will even be a second closing. That's not too much of a problem for us.'

What advice would you offer to an investor new to private equity?
‘New investors should start out by investing via funds of funds, but should try and learn the business quickly. Avoid beginners' mistakes because they have the potential of killing the business altogether - they can be disastrous.

‘If you are large enough and have a sizeable allocation, you should attempt to get into the business yourself. But if you decide to bring the operation in house you need to be fully aware that private equity fund investing is an extremely resource-intensive business.'

How do you see capital flows into the market developing?
‘Over the short term, I doubt that there will be much money flowing in. Many people right now are having to work through a three-year bear market and it will take some time before they start allocating more to equities - both public and private.

‘Over the medium term, an increase in capital flows will really depend on whether private equity can get itself back on a more positive track. Investors need to see some realisations and some positive news. They need to get a lot more money back from their investments at high multiples before they will commit further to private equity. Recently, we have only seen bad news emanate from the industry and investors are aware that it is suffering from substantial problems. As long as this remains the case, then they will stay cautious and will continue to assess the industry with a critical eye.'

What is the biggest mistake that you have ever made?
‘If I can turn the question round, I would say that the biggest mistake that we have avoided is making direct investments. We have never made them because we have never felt that were adequately staffed to do so - and that includes co-investments. I'm not sure that, even if we had had the right staff, a direct investment programme would have gone the right way, anyway.'

What is the biggest issue in the market?
‘Transparency is a big issue for the industry. Limited partners generally do not receive the type of information they need to assess performance accurately on a timely enough basis. This is something the industry needs to work on. Some funds will supply so much data that it is impossible to find the information that you need; other funds go the opposite way.

‘Fees are another big issue in the market right now. The fees charged by general partners have not adjusted to the changing environment we find ourselves in. But I doubt that they will change. There will never be a concerted, orchestrated action by LPs to enforce change in the area of fees. LPs very often negotiate on their own behalf rather than for the good of the other investors in the fund. Besides, LPs all have different incentives and they are often competing against each other for access to the best funds. On occasion, there is room for co-operation between limited partners, but this is rare.

‘I believe that there will be an increased bifurcation of the market. There will be those funds that will have no problem raising money from investors and with these, there will be no room to negotiate terms. There will also be funds that struggle to close and with these, you will be able to negotiate quite easily. The question is whether you want to go with the funds that are willing to negotiate. So I think that there is a lot of wishful thinking among LPs if they believe that fee structures and levels will change. Large institutions may be able to negotiate special terms, but the other investors will almost certainly not benefit from this.'

How do you think that the market will change?
‘I think that a lot of funds will close down operations, there will be a lot of consolidation. But equally, you will find many firms start to narrow their focus to specialise in niches. I believe these funds are likely to do well.

‘Good news will eventually flow out of private equity. While many firms may fall by the wayside, the best managers will do well in these times. We are not pessimistic, although we know that we will have to accept lower returns in the future because leverage is not as widely available as it used to be.

‘We will also see a continuing increase in secondary buy-outs as other exit routes remain effectively blocked off. The problem with secondary buy-outs, though, is that you can end up being a limited partner in both the selling fund and the one that is buying. In that instance, you haven't got an exit, but simply a transfer of assets. That is not good for investors. As a result, I sincerely hope that trade sales remain the most important way of exiting and that they pick up once the general economy starts looking more healthy. The IPO market will take some time to take off again - my estimate would be three years, at least.'

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