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Institutional investor profile, Barry Kohout, Managing Director, Glenmede Trust

Kohout on the lack of fund opportunities in the market, on deciding which funds to re-up with, on annex funds and conflict of interest issues and on why we'll all make the same mistakes we made in the past.

Glenmede Trust was originally set up by the Pew family, the founders of Sun Oil, to be the trustee of the Pew Charitable Foundation. In the 1970s, it started building the business by managing money for other wealthy individuals and now has $15bn under management. Glenmede started investing in private equity in 1989, formalised the programme in 1995 and started offering funds of funds to its high net worth individual and institutional clients in 1998. It now has $750m of commitments to private equity across 62 partnerships. Kohout joined Glenmede in 1996 and was previously at Penn Mutual Life.

What type of investments do you look for?
‘We aim to have a diversified portfolio and so we will look at most things in private equity. We have about 60 per cent of our assets in venture capital and 40 per cent in buy-outs. Within buy-outs, we typically favour the larger funds rather then the mid-market because we feel that the mid-market groups tend to have a harder time getting financing. That seems to be the pattern.

‘As far as countries are concerned, we are very focused on the US. We occasionally invest in Europe, but only in buy-out funds. We don't make venture capital investments in Europe because we are looking for the best opportunities. We feel venture capital is best done in the US, mainly because the exit markets are here.'

Do you look at secondaries?
‘We have recently started looking at secondary investments. We weren't really approached until about two years ago for positions in funds, but we did look at secondary funds before then. We didn't actually invest in them because we felt that there was too much money going into that area of the market. We have been approached more recently for positions, mostly unfunded, and we have even put in a few bids, but we haven't been successful to date. The problem is that it's a tough market to price and so we have a preference for secondary positions in funds we already have commitments to.'

What about direct investments?
‘We don't generally make direct investments - we prefer our GPs to source the best opportunities and so we have done a few co-investments. We don't, however, have a specific allocation for co-investments and we tend to do them on an opportunistic basis. We're not a huge investor and we don't get presented with that many co-investment deals, so it is a very small part of our overall portfolio.'

What do you look for in a fund manager?
‘We generally look for mature groups that have a lot of experience and demonstrated track records. We look for teams that have remained intact and whose strategy hasn't changed. We will always want to know that the people who were responsible for the track record are those that will be making the investments going forward. We will look at first-time funds on a selective basis, but we generally look for managers that are experienced investors.

‘We look at the track record not just in terms of the IRR, but also according to the cash return. There are a lot of funds that raise with great IRRs, but that haven't actually realised that return - we're not interested in these. It helps to be with people who have been through the ups and downs in the 1970s, 1980s and early 1990s. If you just got into the business in 1998, you will have a skewed view of what the market is like in more normal times. I think we are starting to get back to those normal times just now. People can take their time to analyse deals thoroughly before jumping in. The value is now to be had in building businesses, rather than simply flipping them. Our view is that we need to be with people who have the skills to do that.

‘So on the whole, we are looking for people who have been in the industry since before 1996 and who therefore know that the market is cyclical. We want to be committing to managers with in-house operational skills and good networks that will help them source people with the right skills to make businesses grow.'

Where are the most interesting opportunities?
‘Right now, we're not seeing a lot of interesting opportunities. Most of the successful managers are not out raising at the moment. They raised their money in 1999 and 2000 and put it out slowly and steadily. So we're not seeing much this year so far, although there may be one or two coming back to market in second half of this year. We expect a large number of groups we like to come to market in the next two years. We are basically going to be re-upping with some of the groups we are already with.

‘The hard part for us is going to be deciding which ones to go with. Back in 2000, a lot of groups had, say, three great funds. Now, virtually everyone has a troubled fund - we have to decide in each case whether that has to do with circumstances beyond the managers' control or whether the manager hasn't been particularly smart. We will be looking very closely at how quickly money was put to work - the best managers will have maintained a steady and disciplined investment approach. They will have understood that they were going through a bubble and they will have reserved money for later in the cycle when valuations came down.'

When do you think we'll see an improvement in the exit market?
‘I think we'll see a pick-up in the IPO market in the second half of this year, but what scares me is that there is a huge line of portfolio companies just waiting to go public. I think that, initially, we'll see the cream of the crop go to IPO. After that, I think we'll get into a situation in which confidence levels rise and the markets improve, but there will be a rush of companies that maybe aren't so good going public. The result of that will be another slowing in the exit market. Every fund we are invested with has a number of portfolio companies waiting to IPO. You can't float that many companies in a short space of time without some kind of fall-out. It's going to be very interesting.'

What is the biggest issue in the market?
‘I think the exit market is the biggest issue, but allied to that is the issue of whether the older funds - those raised in 1998 or 1999 - will have enough money to see their companies through to the point of exit. Funds that didn't reserve well will be in trouble. The longer the exit markets are delayed, the more this becomes a problem'

Would you ever consider investing in an annex fund?
‘We are looking at an annex fund right now. The problem is that annex funds raise a lot of conflict of interest issues and questions. Which fund are they making investments for? Is it the current or a prior fund? It's OK if you have invested in the prior fund, but not if you're not. How are the profits then shared? How are distributions made to investors in each of the funds? It's very complex.'

What is the biggest mistake that you have made?
‘I'm not sure it's a mistake, but it's something I wish could have been different. The Pew Charitable Trust held up a lot of its private equity allocation because of prudent man laws. Those laws changed in 1999. That meant that we were able to increase our allocation to private equity right at the worst time. So I suppose our biggest mistake was putting 60 per cent of our money out at the peak of the market. Other than that, we have been able to diversify well and we didn't make too many investments in the TMT sector.'

What's your view on the disclosure debate unfolding in the US?
‘My personal view is that the pendulum has swung to the point where the government is trying to protect everyone from everything. The government needs to protect us from fraud and abuse of a system. But people have to understand that there is risk in investing. Disclosing a pension fund's investment performance when private equity funds are in their early years doesn't do anyone any good.

‘If you make all information about private equity publicly available, then you can't fail to damage it. Public disclosure will affect returns. If you look at all the procedures and structures that public companies have to have in place to ensure they are complying with accounting rules, etc, that costs them around $1m a year. Take a small company that is only making $1m to $2m a year. It can't afford to implement those kinds of controls and so it will opt not to take private equity financing. This kind of thing limits the opportunities available to private equity firms.'

How do you think the market will change?
‘I think that we will continue to see cycle as we have in the past. What we're seeing now is business as normal, but I can perfectly see a time in the future when the market will heat up again and we'll see another bubble. It is in the nature of this business to be cyclical. Every time there is a new technology change, it drives us too far and our expectations are initially too high. So that will continue to happen and we'll all make the same mistakes again - it's the way capitalism works and it can't be helped.'

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