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Institutional investor profile: John Otterlei, Senior Managing Director, Piper Jaffray - Private Capital Group

Otterlei on the improving shape of the US venture industry, on the need to address private equity fee structures, on the importance of proprietary deal flow and on looking for firms with a good batting average.

Piper Jaffray is a US-based asset manager and investment bank. Founded in 1895, Piper Jaffray was acquired by US Bancorp in 1998, before gaining independence earlier this year. The publicly listed firm first invested in private equity on its own behalf in the early 1980s, before raising its first direct investment fund for outside investors in 1998. The Private Capital Group was established in 2000 to raise the firm's debut fund of funds. The six-strong investment team currently manages in the region of $192m in fund of funds capital and is preparing for its second fundraising endeavour. Otterlei joined Piper Jaffray in 1978. He spent 20 years in the firm's investment banking divisions, ultimately as head of mergers and acquisitions, before joining the Private Capital Group in 2000.

What type of investments do you look for?

'Our current fund of funds structure allows for investments in both buy-out and venture funds. In terms of venture, we invest purely in the US, and primarily in areas where we have substantial internal expertise such as technology, healthcare and consumer services. Conversely, we avoid industry sectors like energy because it is not a sector in which we have specialist knowledge. On the buy-out side we invest mostly in middle-market US funds

'We like to have some exposure to emerging funds and we have one first time fund in our portfolio. Very large funds would tend to be an exception with us. We usually select buy-out funds that are raising between $150m and $1bn, although we will consider funds that fall outside of those parameters, and the venture funds we invest in tend to be around the $200m mark.'

Do you feel positive about venture in the US?

'I feel very positive about venture. The venture capital market appears to have learnt its lesson after the experiences of recent years. Valuations have come back down to the kind of sustainable levels that we saw in the 1990s and venture firms have become far more disciplined even though there is still a fair amount of capital out there. Entrepreneurs have also experienced a shift in perception. They are no longer basing their choice of venture capital firm purely on valuations. They are also looking for venture firms that will add real value to their boards, that can help them forge strategic relationships and that can help them build their management teams. It's not just about valuations anymore; it's about finding a venture partner.'

Do you invest in secondaries?

'We have invested in secondaries and it is likely that we will again in the future. But secondaries are not a primary focus for us. We are opportunistic about it. We will consider secondary investments that arise in exceptional funds that had already closed when we began investing our capital. We would also consider a secondaries opportunity that arises in a fund that we are already committed to. We do not actively pursue a secondaries strategy but when a good opportunity comes up that certainly warrants significant consideration.'

What size of investment do you typically make?

We typically invest between $5m and $15m in any given fund. We will invest in roughly ten buy-out funds and ten venture funds over an 18 month period.

How do you go about putting together a portfolio?

'First we anticipate which groups are going to be raising funds in the next 18 months. We then map out the sectors that those funds are focused on. We meet with our own internal experts, in the technology, healthcare and consumer sectors, and we discuss which areas we think are going to be the most promising going forward. From that we come up with a rough allocation as to how much we are looking to invest in each sector. However this allocation strategy remains quite flexible throughout the investment cycle.'

How does your investment process actually work?

'We look at everything that comes our way. We proactively identify which funds are of interest and we make sure we are in touch with those funds to see when they are going to be coming to market. It's also a case of letting the fund manager know that we are interested so that a spot is allocated for us. Then we just role up our sleeves and do our due diligence.

'We also use resources outside of our own group to help us identify funds. We utilise Piper Jaffray's investment banking resources and the relationships that they have with firms across the country to help us source investment opportunities. The firm also has dedicated venture capital and leverage buy-out liaison professionals whose daily responsibility it is to go out and build relationships with those firms.'

What qualities do you look for in a private equity manager?

'The cohesion of the management team is absolutely crucial. We look at how long the team has worked together and how much success they have had. We also place a real emphasis on what the culture is for rewarding people within that team. We look at industry expertise and for genuine operating experience. I need to see evidence that a team really knows what it takes to make a company successful.

'Then we slice and dice the team's track record, break it down and delve very deeply to get at the real story. We look at how consistent the team has been in sticking to its strategy and, particularly on the buy-out side, we look carefully at the quality of deal flow and how proprietary that deal flow is.'

What would put you off investing in a fund?

'If a fund is trying to raise too much capital that would certainly be a problem. It would also put us off if a fund's track record and returns have been primarily driven by just two or three investments. To use a baseball analogy, we prefer funds that have a lot of doubles and triples. A good batting average is very important. Teams that haven't worked together very long is a problem for us also.'

What advice would you give to a new investor in private equity?

Is gaining access to the best funds becoming a real issue for LPs?

'Getting access is a real issue now because most of funds are raising less capital that they have done previously. At the same time investor appetite is picking up, which is compounding the problem.'

What has been your biggest mistake as an investor in private equity?

'In hindsight our biggest mistake was probably launching our fund of funds in 2000 rather than 2001. It was very hard to differentiate between funds at the peak of the bubble because so many firms were getting incredible returns.'

What do you think is the biggest issue in the private equity market at the moment?

'I think the biggest issue in the private equity market at the moment is the industry's fee structure. There has been a small amount of progress with some venture funds reducing their fees. But there is still a very long way to go.'

How do you think the private equity market will evolve going into the future?

'In the 25 years in which I have been involved in private equity the market has grown immensely. Private equity has also become a lot more institutionalised and professional. I believe that growth will continue on both the buy-out and venture side and that the development of the private equity industry will continue to benefit the economy as a whole. A company no longer has to wait for a public offering in order to get the capital it needs to grow. This means that companies can stay private a lot longer. We are not as dependent on a strong IPO market as we used to be.

'Going into the future I think that the middle-market will continue to thrive while mega-funds and very small funds will become less common. The best managers will continue to raise money without difficulty and will grow. The less successful firms will fall by the way side.

'I think there will also be significant developments in the fund of funds industry. The asset-gathering mentality of some fund of funds managers is going to have to change. I think we are also going to see changes in fund of funds pricing structures to a more cost based fee structure where the interests of fund of funds manager is more closely aligned with their LPs.'

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