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Institutional investor profile: Hans van Swaay, Head of Private Equity, Pictet & Cie

Van Swaay on private equity as a maturing industry, on the failed ambitions of some mid-market firms, on the negatives of negotiation and on the problems of secondary buy-outs.

Based in Geneva, Pictet & Cie is one of the largest independent private banks in Switzerland with E135bn under management. It has been investing in private equity for around 20 years, but has had a more formal programme for its clients for the last 12 years. It invests mainly on behalf of its private clients, but has more recently started offering services to select institutions and has a E3.7bn private equity exposure. Pictet invests the majority of its portfolio in buy-outs across Europe and in the US, although it also has smaller allocations to venture capital, mezzanine and secondaries. Van Swaay joined Pictet in 2000 and was previously involved in direct private equity investments at UBS.

How are your private equity investments structured?
‘We are not structured as a fund of funds, although I wouldn’t rule out raising a fund of funds at some point in the future. Instead, we have a more flexible structure that we think is appropriate for private banking. Our clients tend to be fairly large families and private individuals who like to have more involvement in their investments than institutions might do. They tend to have more influence over which funds they make commitments to. Our clients can be part of a larger pool, but the individual investments can vary from client to client. It’s more of a fiduciary arrangement than a straight fund of funds and it tends to be rather cheaper. This works because of the clients that we work with. If we were ever to work with clients with a smaller amount of capital to invest, then we would structure a fund of funds product to cater for their needs.

‘This structure also allows us to tailor our investment rate according to the investment opportunities that are available and to our clients’ wishes. So, for example, our investment rate picked up a few years ago and has remained flat for the last couple of years. We are starting to pick up now, though.’

Why is your investment pace picking up now?
‘This is partly to do with the nature of private equity itself and partly to do with the nature of our clients. We haven’t had the defaults that some other private banks have had. Our clients tend to be larger families that take a long-term perspective – they are building up a portfolio for future generations. Many of them are now looking to increase the amount they are investing in private equity or are looking to start committing if they haven’t previously been in the market.

‘But the other area of the market in which we are seeing growth is among family offices. Pictet is well known for the global custody services it provides. We have also recently developed this capability in the private equity side. There are a lot of family offices that invest in private equity. Many of them have small teams and have difficulty managing the cash flows and working out what the performance on their private equity portfolio has been. We provide administrative services to help them manage this, for which we have developed our own software. This provides a first entry point into our bank for these family offices and we hope that that then leads to higher value-added services.’

What type of investments do you look for?
‘We invest heavily in buy-outs and we are likely to continue doing so in the future. Our philosophy is that a heavy exposure to buy-out funds suits our client profile better than, say, investing a large proportion of capital in venture capital. Buy-outs are less volatile and they are easier for clients to comprehend. Typically, we would have 20 per cent to 25 per cent in venture capital, with the rest in buy-out related investments, in which we would include mezzanine and distressed, plus a small number of secondary positions.

‘On a geographic scale, the majority of our investments have historically tended to be in the US, but we do also invest about a third of the portfolio in Europe. We are increasingly looking at Europe as we believe that there are some very good buy-out opportunities there. On the venture side, we will continue to look mainly at US opportunities, simply because we believe that venture capital is done better there than in Europe. We don’t really look outside these regions as we are not convinced that any of the other markets, such as Asia and Latin America, are developed enough yet.’

How has your investment pace in secondaries changed over recent years?
‘We have been investing more in secondaries recently. Some of the opportunities that we have seen have simply been too good to pass up. We tend to look at smaller ones, the situations in which the seller wants a discreet sale. We’re not competing in the $20m-plus league – there are plenty of other people out there doing that already.’

What about direct and co-investments?
‘We have done some co-investments, particularly on the buy-out front. They have been very successful. On average, we have had significantly better returns on co-investments than fund investments, but that is because we have been involved in very good ones. Good buy-out funds, when they allow you to co-invest, will offer you some great opportunities. It’s the theory that if you’re inviting someone round for dinner, you make your favourite dish, you don’t experiment on your guests.

‘As far as direct investments are concerned, we do make them sometimes but it’s very rare. On a select or discreet basis, we occasionally get involved in direct investments when clients bring deals to us, but it’s not really our mandate.’

How do you source opportunities?
‘Pictet has the luxury of being sufficiently well known and so a lot of people come to us. My background on the direct side also means that I know a lot of the funds anyway. We travel a lot and talk to people. Often the best opportunities come through conversations we have with other people in the market. We also conduct research on particular parts of the market and that often brings up funds that we may not previously have heard of. We can then be proactive in finding out more about them. If you look at our portfolio, you’ll see all the famous names in there, but you’ll also see a few that are less well known.’

What are your return expectations?
‘We haven’t changed our return expectations over the longer term. We still expect to generate 500 basis points over stock market indexes. Over the short-term, however, we are realistic. We don’t think the last few vintages will bring us fantastic returns. But if you can’t get a decent return over the longer term, you have to question why you are in the market at all.’

What do you look for in a private equity manager?
‘There are three simple criteria that we look for. The managers have to be experienced. There is a saying that it takes about $30m to learn private equity. You could debate about the precise amount it takes for ever, but I think there’s a lot of merit in the saying. You have to learn private equity through experience. No matter how clever someone is, they will always make mistakes to begin with. I’d rather they didn’t do that with our clients’ money.

‘The managers have to have been in a particular market for a long period of time. It takes years to develop the right network. Some have funds jumped into Germany over the years, for example, without having operated there before; what they didn’t realise was that it takes a long time to build a firm and a name in a market.

‘The third main factor is the ability to add value. Pretty much everyone agrees nowadays that the days of multiple arbitrage are over. Economies are also experiencing a period of low growth. Managers have to be able to work a company harder now than they have had to previously. You can only do this by having a lot of people on the ground and by being actively involved – that doesn’t mean they should get in the way; they just have to know what they are doing. There is a model that seems to be gaining ground at the moment – and it’s one we find quite interesting. In this model, you have two or more areas of the business: transactors who do the deals, and operational partners, who really know how to help build the company.

‘None of this is rocket science. It’s actually quite simple. You need smart people, but you also need experience, an inside out knowledge of your market and a good level of resources on the ground.’

But are you seeing many funds that have these characteristics?
‘We see a lot of good firms and they share these characteristics. But if you extrapolate that, you will find an increasing degree of specialisation in the industry. We are faced with the question of whether private equity as an industry is maturing. We believe it is. Like any widget-making industry, we have seen rapid growth – albeit followed by a temporary slowdown – and you can see the private equity universe crystallising as a result. Large firms have established a niche by concentrating on big deals, you’re increasingly seeing industry specialisation among other firms, especially in the mid-market arena, and there is also regional specialisation.

‘One of my worries, however, is about the mid-market. Yes, many of them are attempting to differentiate themselves through sector or regional specialisation, but I think that a lot of people just end up there rather than making a conscious choice to work in a particular area and to manage a certain level of capital. My concern is that many of the mid-market firms have wanted to grow in size to compete with the big firms, but haven’t managed it by the same token, they haven’t had the discipline to remain small. They are in a kind of no-man’s land and are having to deal with the consequences of that by coming up with a story they believe they can sell to investors. I’m not saying that there aren’t any good mid-market players – far from it. All I’m saying is that the current popularity of the mid-market is overdone.’

What is your appetite for first-time funds?
‘We do look at first-time funds, but not on a large scale. I always say to people that we are not paid to be brave – we are paid to make the right investment decisions for our clients. Private equity is one of the few areas of the financial markets in which past performance is a very good indication of the future performance. If you accept that, then you have to ask the question of why you should take unnecessary risks. There may be some very compelling reasons. You may see an excellent team that has come out of an established player, for example, that are in a specialised sector. Under those circumstances, we may invest with that team. But I’d rather not make a strategy out of backing first-time funds. It may be that we should look a little more closely at this area as more groups spin out. Private equity is a boutique market and so you will continue to see smaller groups spinning out. But we haven’t yet devised a technique to predict the outcomes of investing in first-time funds.’

In which areas of the market would you like to see change?
‘I think that there could be some development in the area of fees. In some respects, the debate surrounding fees is an overblown one. I believe that managers that perform well receive appropriate remuneration for their work. But the issue I have is with those that don’t perform well. You need to look at the fees and other costs involved in investing in a fund against the value of that fund. If you are in negative performance territory, then the current model breaks down. Managers are still able to make a good living even if their fund isn’t doing well, and yet their investors suffer. It’s here that the model is flawed. Of course, you have the sanction of not investing in a future fund, but that doesn’t help you much in your current investment.’

So what kind of model would you suggest?
‘I think there are two possibilities. One would be to find a way to relate fees to net asset values. That is obviously open to debate because of the subjective nature of valuing a portfolio, but there may be some ways around this. Another would be to make the investment period shorter – and this is a model I would advocate. It would mean that groups would have to raise money more frequently, but there are a few groups that already do this and if they are good, then fundraising becomes less of an issue. One of the best known of these is Alchemy, in which investors commit on a yearly basis. This means that at least you are not stuck with an investment for years on end.’

What about other terms?
‘If you are investing with the well known groups, then you tend not to negotiate. In fact, I think that there is too much negotiation going on right now. In the end, most of these negotiations add very little value unless you are placing, say, E150m in a fund. And actually, all it tends to do is increase your costs. Of course, it is possible to negotiate with newer groups. We recently invested in a first-time fund and negotiated the terms with them, but the upshot was that we helped them put together a better structure.

‘With the mature groups, I think the value-added of negotiating is pretty much nil, it’s very costly and it prolongs the whole process. I’d be very much in favour of the development of a standardised limited partnership agreement.’

What irritates you about private equity?
‘This is becoming less of an issue now, but there were a lot of bad first-time funds in the market. Many of them pretended they were doing a good job when they were not and they continued drawing management fees even when they were doing badly. That is a major irritant because they spoil the market for the rest. It’s a difficult decision, but I think many of these people should have just cut everyone’s losses and walked away. They should have kept their professional reputations intact rather that struggling to get one more year’s worth of management fees.’

Do you not believe that limited partners have a role to play in this?
‘In theory, yes they do. But in actual fact, they do very little. It’s just not practical. If you have 50 to 100 limited partners in a fund, it’s extremely difficult and time-consuming to get 75 per cent of them to agree to take action and force change. I’ve not seen anyone manage to do it, except in instances of fraud or when the fund is a captive. Otherwise, rallying 75 per cent of investors doesn’t work. Again, this is where having shorter investment periods would help.’

What is the biggest mistake that you have made?
‘I think my biggest mistake is one shared by pretty much everyone else. We got excited about the venture space and made direct investments in the late 1990s, along with almost all other investors. We forgot a few basic investment rules and were too hurried and too greedy. But we were fortunate in that we didn’t invest too much money in this area. Luckily, we are disciplined and have a good level of diversification in our portfolio.’

What is the biggest issue in the market?
‘Over the short-term, I think fundraising will continue to be a big issue. The funds that are perceived to be the best will have no problem fundraising and in most cases will be oversubscribed; those that are average will struggle. I think we’re already seeing this.

‘I think another issue is the increased trend for secondary buy-outs. I think it’s a scary development if you take it to extremes. A lot of these deals are syndicated. This means that, although you have chosen to invest in a particular group over its competitors, you’re still going to be investing in the same deals as if you had chosen a competitor. That’s one aspect of it, but the other is that they are all buying from and selling to each other. That can’t be right. I fully understand that exits are difficult at the moment and secondary buy-outs are one of the few means of realising an investment right now. But I would like to see a decrease in the number of sales to financial buyers when the market picks up. We have already seen situations in which we have been invested in both the seller and the buyer of a particular asset. That is giving with one hand and taking with another and it’s not healthy.

‘In the end, I think you should only invest in a company if you think that there is an industrial logic for another company to buy that asset in the future. That is creating value.’

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