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Institutional Investor Profile: Charl Pienaar and Steve Whatmore, Investment Managers, MLC Investment Management

Pienaar and Whatmore on private equity opportunities in the Asia-Pacific region, on the risk of rejecting a great manager, on the dangers of excessive capital inflow into the industry and on the importance of looking before you leap.

Why does MLC invest in private equity?
Pienaar: 'In order to fully answer that question it is important to consider the context of the Australian pension market. In the 1980s the Australian government launched a programme to try and establish a fully funded pension scheme and it did so by taking three per cent directly out of every pay packet. When you take into account the growth in wages over the last two decades and the accumulation of those earnings, what that means is there is now a very substantial pool of pension assets being built up in this country.

'But because our environment here is shaped by defined contribution schemes rather than defined benefit, we have very little capacity for illiquidity. We therefore have to look very carefully at how we want to use this scarce resource. MLC's policy is very definitely to put it to work with a strong returns focus. This is illustrated by the fact that our A$2bn programme is only committed to A$1bn and drawn down to A$600m. It is a fundamental article of faith for us that you do not fill a mandate in this business. If you want to make outsized returns you must only commit when you have absolute conviction in a proposition.'

What type of investments do you look for?
Pienaar: 'We seek to develop and actively maintain relationships with a relatively concentrated group of elite venture capital and buyout management firms around the world. We also complement our own efforts with a small number of fund of funds relationships.

'We are regionally agnostic, but we do require that a region is supportive of private equity investing. This supportive environment may manifest itself in a number of different ways. It can be found in a region's economic growth, capital markets, debt markets, the mobility of management and the infrastructure surrounding the private equity industry. This bottom up approach has led us to a situation where we have 50 per cent of our commitments in Europe, 45 per cent in the US and five per cent in Australia.'

Whatmore: 'We have approximately 40 per cent of our commitments invested in venture funds, primarily early-stage, and 60 per cent in buy-outs. While we have the mandate to explore the debt-based private equity sectors such as mezzanine and subordinated debt, we have chosen to concentrate on those sectors where we believe return out performance can be generated. This has lead us to a strong exposure to early-stage venture and a class we refer to as activist buy-outs. By that I mean GPs who intend to have some impact beyond the purely financial.

'We are very focussed in terms of the number of general partners that we invest with, and this is another reflection of our strong returns motivation. We don't feel that having 50 or 60 GP relationships will serve us well in achieving our returns ambitions. We are currently invested with 14 firms in about 24 funds and we do not intend to increase the number of GPs that we are invested with to much more than 20. In comparison to other similar sized programmes we think it's quite a concentrated strategy.'

Do you invest in country specific or pan-European funds?
Pienaar: 'To date our exposure has been weighted towards Pan European firms. Now, having laid down that base of pan-European exposure and having begun to understand Europe better, we are beginning to look at opportunities on a regional and a country specific level. We have, in fact, already committed to one regional group in Scandinavia.'

What are your views on the global venture market?
Whatmore: 'I would say that things in the US are definitely starting to improve. The whole liquidity of the sector is opening up, in terms of both deal flow and exits. We are a little nervous about the massive institutional appetite for venture investing, given that in our view it's not a particularly scaleable opportunity. So in that regard, there is still somewhat of a question mark over the sector.'

Pienaar: 'Most of our venture exposure is currently in the US, although we are invested with one pure venture firm in Europe and one generalist firm that invest partly in early-stage firms. I would say we are cautious about European venture but I don't think there is any sector that can be dismissed in its entirety. It is a question of enhanced selectivity.'

How would you describe private equity opportunities in the Asia-Pacific region?
Whatmore: 'To date we have been relatively cautious in the Asia Pacific region. We have supported two groups here in Australia, both of which have produced very strong returns. But in Asia itself we have yet to see the types of returns being generated that would urge us to embrace the investing risks that are inherent in that region. I have a sense that this may well be changing and we are now seeing some groups emerging with more consistent track records and strong management skills, particularly in Northern Asia. But we are not yet sufficiently convinced to take this further.'

Pienaar: 'The Australian market has been extremely good for us and I would expect that this latest vintage year of managers is going to penetrate the top decile on a global basis. But it is a relatively small market and our approach has never been to manage a programme with any particular home, or other regional, bias.'

Do you invest in Secondaries opportunities?
Pienaar: 'We have invested in one secondaries fund, but it was more in the nature of an adjunct to an existing relationship. We are interested in secondaries but we would see them principally as being an extension of our primary programme. We do, however, have an open mind.'

What size of investment do you typically make?
Pienaar: 'Our bite size is typically between US$20m and US$30m.'

How do you go about putting a portfolio together?
Pienaar: 'We are essentially bottom up in our portfolio construction. The top down element only comes at a very broad thematic level. We don't pursue diversification as a strategy in itself. We follow the best opportunities we can find and that is what has lead us to the current allocation model that we have. We do have a desire to keep our early-stage venture exposure up, but whether or not we are going to be able to maintain our current ratio remains to be seen. I think it is probably unlikely going forward.'

How do you find out about good investment opportunities?
Whatmore: 'Obviously, here in Sydney, we are based some distance from our primary target markets. It has taken us a lot of time, a lot of air travel and a lot of walking the streets of San Francisco, to actually develop a network and a knowledge base, which then converts into something like a radar screen for the opportunities that we are interested in.'

How does your due diligence process actually work?
Pienaar: 'We approach due diligence from the perspective of people who have invested as principals in their pasts. We tend to start by looking at the deals themselves, as well as investment strategy and the specifics of the markets involved.'

Whatmore: 'We also spend a great deal of time in front of the general partners. We talk through deals, stress testing strategy and motivation and forming a mutual understanding.'

What do you look for in a good private equity manager?
Pienaar: 'In addition to the obvious qualities such as track record, deal origination, and a consistent and focussed strategy, we also look very closely at the organisational structure of the team, and of course, the terms and conditions.'

What would put you off investing in a fund?
Pienaar: 'It can really come from any direction. But if we find a strong disconnect between a managers stated direction and evidence of that direction, we would not proceed with an investment. We don't like to see any inconsistency and so we always look for proof of rhetoric.'

How would you describe your appetite for first time funds?
Whatmore: 'We are cautious but open-minded. We do not have a first time fund policy, it really depends on where that first time fund, and the general partners managing it, have really come from. It depends on the experience within the team.'

What advice would you give a new investor in private equity?
Pienaar: 'In today's market, access to the best is incredibly important. Unless an investor is certain that they can access top tier funds, I think they should question their assumptions that this is an entirely rosy sector to be in. Secondly, investors must ensure that they have the skills to properly evaluate private equity investments. Because unless you have total conviction in a group, after having pulled that group apart, you must not invest.'

Whatmore: 'My advice would be to make sure that that the entrant fully understands what it hopes to achieve from private equity investing. It is important to spend time forming and articulating a clear strategy. The investor then needs to look within their organisation to evaluate whether the skill base to execute that strategy exists in-house or whether some outsourcing is necessary. Dabbling in private equity with the intention of learning by experience is highly unlikely to reap rewards. So my advice would be, look before you leap.'

What is the biggest mistake that you have made as a private equity investor?
Pienaar: 'I think we constantly face the risk of rejecting a great manager and we know that this is something that we have done in the past. It is much easier to reject than to accept, and in the end it is always a highly subjective decision making process. We are probably victims of our own strategy in a way. We are only forming three to five new relationships per annum so the kind of rationing decisions that we make can be quite agonising at times.

'It is often hard to recognise a group of people who are purely and simply great investors. The more you look for a story that defines and describes them, the more distracted you can become from their underlying talent. I think that when we first started out we were looking for stories, some nice little off the shelf description, but in the end people are either great investors or they are not. But whatever happens, it will take some time before we really know the implications of the decisions we have made. You marry in haste and repent at leisure in this business.'

Whatmore: 'When I look back over the last seven years I can point to a number of decisions that have been made that, in hindsight, we might have reversed. It has take time for us to learn to recognise the intuitive abilities of great investors, in addition to simply trawling through the endless boxes that we all like to tick.'

What would you say is the biggest issue in the private equity market?
Pienaar: 'I would say that the biggest issue in the industry at the moment is the excessive inflows of capital that threaten to destroy the innate advantages of private equity investing. There could well be tears ahead in many areas of the business if this is not curbed.'

How do you expect the private equity market to evolve going into the future?
Whatmore: 'My sense is that both in later-stage buy-outs and in early-stage venture the evolution of global firms is really going to kick in. This will in turn mean that a gap in the market will emerge for regional, or more niche operators, underneath those global firms.'

Pienaar: 'I think there is a sector of the industry that is standing by ready to provide small premiums over the public markets, and if that is what investors are seeking, then that is a very valuable service. However, if you are seeking something above that, you will have to be much more cautious, flexible and selective.'

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