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Institutional Investor Profile: Mark R. Pattis, Chief Executive Officer, Next Chapter Holdings

Pattis on the potential for returns in emerging markets, on the importance of a cohesive general partner team, on the issue of generational transfers and management motivation, and on why family offices can make very attractive LPs.

Next Chapter Holdings is the family office responsible for managing the investments of the Pattis family. Based in Highland Park, Illinois, the firm's strategy is to invest in a diversified range of asset classes with a special focus on alternative investments including private equity, real estate, natural resources, and hedge funds. The firm first invested in private equity in the late 1980s and currently invests in the region of 15 per cent of its total capital under management in both direct and fund investments.

Why do you invest in private equity?

‘The liquidity for the Pattis family’s investments resulted primarily from three start-up businesses in the media industry, each of which was subsequently acquired by a public company. In other words, having started, developed and ultimately sold these privately owned operating businesses, we made our money through private equity and entrepreneurship. What this means is that we have a predisposition towards investing in the asset class.

‘We believe that private equity has a number of advantages for investors. First and foremost, the owners of a private company really do control what happens in its growth and development. This means that you have a far better alignment of interests between ownership and management than you would in a publicly held company.

‘In addition, there is also an illiquidity premium in private equity. Our orientation, as a family, is very much towards long-term investments. Our mission is capital preservation and growth for subsequent generations as opposed to current income.’

What types of investments do you look for?

‘We believe very strongly in diversification, by geography, industry, enterprise value and vintage. In comparison to your average Mid-Western family we tend to be pretty adventurous and we are relatively active internationally. We do invest in Western Europe, we also invest in Asia, Latin America and even Eastern Europe. In fact, we have just received a capital call on a private equity media investment in Russia.

‘But although we are very open-minded geographically, we are sceptical of investing in US transplants. That is how I refer to firms that send a couple of people to London or Hong Kong and call themselves European or global specialists. We prefer to invest with local established teams.

‘With regards to the size of the funds that we invest in, we have committed to a number of high profile, brand name buy-out funds, but then at the other end of the spectrum we also have exposure to some regional, lower middle-market funds that you may never have heard of. I view that as a vital part of diversification. In terms of investment stage, while we are now investing more seriously in venture capital, we remain heavily weighted towards buy-outs.’

Are there any areas that you think are particularly exciting at the moment?

‘I would say that Japan is a very exciting market. We began committing to Japanese funds in early 2003. We have been rewarded well so far and it is an area that we are continuing to devote money to. I would also say that there are a number of very interesting emerging markets, in particular Russia.

‘Our investment focus has also tended to emphasise certain industry themes. We have recently been over weighted towards biotech which is an industry that we believe will really flourish over the next ten or 20 years. And of course, because of our backgrounds, as well as the healthy investment credentials of the sector, we also have a significant focus on media funds.’

How do you go about putting a portfolio together in terms of your allocation strategy?

‘I would say we are opportunistic within the confines of a prudent, portfolio balancing, institutional mentality.’

How do you find out about good investment opportunities?

‘We have a great deal of interaction with other family offices around the world. Our existing managers are also a very good source for us. In addition, we tend to re-up with firms that have served us well.

How many investments do you look to make in a year?

‘The average fund raising cycle is between three and four years. We aim to have around 40 funds in our portfolio, so we are generally looking at investing in between ten and 12 funds per year.’

Do you invest in secondaries opportunities at all?

‘We have chosen not to invest in secondaries funds, largely because we already have exposure to the vintage years that are on offer. In addition to that, a lot of secondaries opportunities are now auctioned, so you have to ask yourself whether there really is any added value there.

‘We have, however, purchased the occasional secondary position directly. But this is the exception rather than the rule.’

What do you look for in a good fund manager?

‘First and foremost we look for a cohesive team made up of really smart people that are committed emotionally as well as financially. Hopefully that team will be backed by a long and successful track record, but that is not always essential.

What would put you off investing in a fund?

‘We are more cautious with first time funds although that it is not to say that we will never commit. Any team where there have been a number of changes or departures will also act as somewhat of a red flag.’

How do you actually conduct your due diligence?

‘Typically, we like to pre qualify funds qualitatively before we ever meet with them. We look very closely at their generic documentation but do not ask them to fill out anything specific. We usually have one or two meetings with the team and then we make a decision.

‘As we are not fiduciaries for other people’s money, we are able to make quick decisions and we are relatively low maintenance both going into a fund and throughout the fund’s life. We just don’t have that same watch your back mentality. We have been known to make a decision and to have completed documentation within 48 hours.’

What advice would you give a new investor in a fund?

‘The first thing to do is to get familiar with the asset class through a fund of funds. If you literally have no private equity experience this could prove an invaluable learning curve and also provides essential diversification.’

What would say is the biggest issue in the industry at the moment?

‘Inter generational transfers are a huge issue. A lot of the big names that built up successful track records at the over subscribed large-cap funds, are not the ones that are going to be doing the work going forward. As an investor you are not interested in what is going on in the rear view mirror, you want to know what is going to happen in the future.

‘When we make an investment, we want to feel confident that the team that we are doing business with is the same team that will be there in ten years time. If they are too young, you wonder if they really have the commitment and motivation to stay the course. If they are too old and too rich, you wonder if they have the kind of hunger that is essential to generate returns. More than anything it comes down to the individuals. Some will die with their boots on while others will bail when the first opportunity arises.

‘The question of accessing big name funds is also certainly an issue, but it is really something that we take for granted. There is no way that Mark Pattis is going to be able to invest in Kleiner Perkins or Sequoia. That is a fact of life. Having said that, I think family offices can often gain access to relatively closed funds simply because general partners are tired of dealing with institutions that make them jump through hoops.’

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

‘I think that as private equity’s collective track record grows, the industry will continue to expand. The public markets have received a rather high profile battering with the much publicised disgracing of the likes of Enron and WorldCom. Investors are inevitably, therefore, becoming increasingly drawn to the private equity model where the owner ultimately determines the course that the business takes. Of course, it is possible to bet on the wrong people in private equity too, but as long as you seek out financially astute individuals with experience and integrity, you will enjoy the benefits of the asset class.’

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