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Institutional investor profile: Ronald Sandquist, Managing Director - Private Equity, Advantus Capital Management

Sandquist on telling the bad news as well as the good, on being passionate about building businesses, on the tricky business of judging a fund by its track record, on the irritations of management fees and on patient investing.

Based in St Paul, Minnesota, Advantus Capital Management is an affiliate of Minnesota Life Insurance Company. It was formed in the mid 1980s, principally to invest Minnesota Life capital, but also to service other third-party clients. Advantus currently has $14bn under management, invested across a range of asset types, including bonds, mortgages and equities. Its private equity investments currently stand at around £220m and commitments since inception of the programme total over $600m. Advantus invests mainly in US venture capital funds, but also has exposure to buy-out and mezzanine debt funds. Sandquist joined Advantus in 1962.

What type of investments do you look for?
‘We seek to have a balanced portfolio over time in private equity. We started investing in private equity in 1982 and our programme has evolved over time to include all sub-types of private equity, from venture capital and buy-outs to mezzanine debt. We also have a smaller exposure to arbitrage-type strategies and CDO and CLO funds.

‘Venture capital funds make up the largest share of our portfolio, followed by buy-out funds. We don't have a set allocation to different types of private equity. We prefer our portfolio to be dynamic and we like the flexibility of being opportunistic in our approach. Just recently, for example, we have been concentrating on finding good mezzanine fund opportunities because we felt that our exposure to venture and buy-outs was about as high as we wanted it to be for the meantime.

‘We invest almost exclusively in the US. We do have a few non-domestic fund investments, but these all have a connection with the US in some way.'

Why do you focus more heavily on venture capital than other types of private equity?
‘We actually focus heavily on early-stage venture more than venture in general. The reason for this is that we believe this is where we can achieve highest returns. If you look back at historical records of private equity returns, the greatest share of these comes from early-stage venture. The greatest value that a venture capitalist can add to a business tends to be at the earliest stages of its existence.'

Do you make direct investments?
‘We don't do direct or co-investments; we simply invest in funds. We believe that to do direct investments successfully requires a totally different skill set from that required to be a fund investor. Direct investing is a very time-intensive activity and so you need a much higher staffing level, too. For the same reason, we don't do secondary transactions, either. You really have to know what you're doing in these areas - and successful investing is about recognising where your strengths and limitations lie. We have taken the decision to stick with what we're good at - fund investing.'

What do you look for in a private equity manager?
‘There are a number of qualities that we look for when we are investing in a fund. The most important for us is that the group has the experience and a track record of building businesses. By that, I mean that the team must be able to add value to their investments - because they have contacts that are potential customers for the portfolio company, or they are able to recruit people from the industry to work with the company in a management capacity, and so on. In short, they need to know what it takes to build a business.

‘We also look for integrity and a fiduciary mindset in teams. They need to be aware of our requirement to report to our constituents. They need to be open with us and tell us the bad news as well as the good. That is very important for us.

‘We look for teams that are not over-extended. The partners need to have the time to devote to new investments. And we look for teams that have worked together for a number of years, preferably through more than one investment cycle.

‘The other important factor for us is that the organisation is well managed. We want to see evidence that issues such as succession have been taken care of and that there is a development plan for the more junior members of the team and for the firm itself.

‘A passion for the business is essential, regardless of personal wealth accumulated. There are some partners out there that are now extremely wealthy, but they still love what they do. Money is important to them and may be what drives them, but their main motivation is a passion for building businesses. That's the kind of people we want to back.

‘Last, but still important, is the rapport we as a team have with the group. Private equity is a long-term game that's difficult to get out of. Partly, this is because my view is that life is too short to spend with people you don't like and don't get along with. But it's also partly because, if we find GPs to be too arrogant, for example, there's every chance that entrepreneurs will be put off by them, too.'

How important is track record to you?
‘Track record is very important to us. But it's not the whole story. Take one of the firms that we invested with back in the late 1980s, for example. When the group was out fundraising, the interim IRR on its previous fund was not that great. We analysed the situation and looked at the things most important to us and we noticed that they were doing all the right things - building businesses, etc, even though the exit market was not there (it was a similar situation to what we're seeing today). So we decided to go with them, despite the fact that their returns weren't great. Other investors that we knew turned them away because they felt the returns were too weak. Anyway, the fund did really well, as did the next one. Those investors that didn't commit when we did never got back in - the group did so well that it could afford to cut out investors. That just illustrates the importance of looking beyond the returns.

‘And I'd say that this is particularly important in today's market. These are some of the weakest returns I've seen, and so you have to delve deeply to see whether you believe that a group can perform well in the future. That's the thing about this business - it's not just about what's happening today, it's about what will be happening in three years. And that's why we make sure that we make investments steadily over the years and beyond. We understand the importance of having vintage year diversification because you never know when is going to be the best time. You can't time the private equity market.'

What puts you off an investment?
‘Well, there are obvious factors, such as the fact that a fund's strategy is to invest in areas where we have no interest. In the early-stage arena, for example, we like areas that don't take huge amounts of capital investment. But, other than that, one example I can give is of a fund we rejected after speaking to a trusted source regarding a reference check. He told me that one of the general partners was not at all constructive in board meetings and acted as if he knew it all. That is the type of fund we avoid.'

What is the biggest mistake that you have ever made?
‘One of the most important things that you have to look for in people is investment judgment. But that is only one part of the equation. They also have to have integrity, otherwise it doesn't work for us. So, as investors, we need a combination of the two. I think the mistakes I have made have been when I have invested with a team that had the integrity, good follow-through, reporting, etc, but that didn't have the investment judgment required when it came down to it. Some people have a real knack of investing in the right areas and companies; others don't. It something that can be quite difficult to decipher at times, especially when everything else is in place. But luckily, that has only happened a couple of times.'

What irritates you about private equity?
‘We, as limited partners, pay general partners what I consider to be generous management fees. I think that is appropriate because they enable GPs to conduct their business and I have no objection to paying them if their returns are good. But what irritates me is paying those management fees when there is little or no return at the end of the fund. It's irritating because limited partners have ended up with nothing, while the general partners have managed to live a very comfortable life.'

What is the biggest issue in the market at the moment?
‘The biggest issue relates to the disclosure and confidentiality issue that is unfolding in the US. I think there is a real need for education and communication. If the public knew more about the nature of the private equity business, there would not be the lack of understanding that we currently see. Publishing interim results on a web site is not helpful. What are people going to do with those figures? They provide no meaningful picture of how any given investment will do at the end of a fund's life. The industry needs to take it on itself to educate the public, or whoever is interested in private equity. That way, we will end up with more of a balance in the demands for disclosure. I believe that there has to be some degree of disclosure, as long as it doesn't break confidentiality agreements. But GPs have to be able to conduct their business and, if calls for the disclosure of portfolio company information are heeded, that would severely damage that ability.

‘Ultimately, I hope that the legislative bodies realise that wholesale disclosure will actually hurt the public, not help it. The incidence of GPs refusing to accept money from public institutions will limit their ability to invest in some of the best funds that private equity has to offer. How is that in the interest of the pension plan members?'

How do you think that the market will change in the future?
‘I think it will be a long time before we see the kind of returns we saw in the 1999/2000 period, when valuations were so out of line with historical levels. I see a future of more rational private equity investing - that is a good thing. Only companies that deserve funding will get it. I'm optimistic about the future, but I think that we will all have to be patient. We are back to seeing returns over a five to seven-year timeframe and that demands patient investing. In fact, we are back to business as usual.'

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