PRINT THIS PAGE Institutional Investor Profile: Barry Gonder, General Partner, Grove Street Advisors03/05/2005. Source: AltAssets. 
Barry Gonder on why all of Grove Street Advisors's portfolios are structured differently and on why he thinks that the risk associated with first-time funds is often overestimated. When Gonder joined Grove Street from the California Public Employees' Retirement System in 2001 he had already worked in investment for 12 years, having gained experience of both direct equity investments in companies and fund investments. At CalPERS he led the private equity programme from its infancy to $19bn in commitments - out of which $10bn had been invested - after five and a half years.  Grove Street is based in Wellesley, Massachusetts and has a small satellite office in San Francisco. The firm runs separate accounts - funds of funds - for institutional and high-net-worth clients. Each client gets a customised portfolio to reflect their needs and preferences. Right now Grove Street is working with six clients, five major institutions and one high-net-worth family. All of the firm's partners and professionals had had extensive operating experience in private equity before they came to Grove Street. The 30-strong team currently has €3bn of assets under management. AlpInvest, LGPI of Finland, and the States of Florida and Oregon are among the firm's clients.
What type of investments do you look for?
Each of our programmes is different because we customise our funds of funds to each of our clients but if you combine them all you will find that we invest across the full range of private equity - venture capital, equity buy-outs and special situations.
Breaking down our portfolio we have about 50 per cent venture and 50 per cent buy-outs. On the venture side we focus primarily on the United States and Israel, and on the buy-out side our focus is on Europe, the United States and increasingly on Asia. For buy-out and growth equity funds we are primarily interested in partnerships focusing on the small end of the market where we believe the best value and potential for return is.
We invest most of our money into proven, top-tier firms that are expected to generate great returns. However, there is a stability issue with those firms: partners may be retiring or the firm may be breaking up for internal reasons. Plus it is tough to access those great proven firms. We have access to a lot of them but we also think it is important to bring some fresh blood into the portfolios of our clients. By investing with a new promising group you do not only have the potential to have access to a great fund over time, but often those groups are so highly motivated that they come up with returns as good as the returns of the proven, top-tier firms.
How do you assess the risk associated with new firms?
We believe that the team instability issue of newly formed teams is not as big a risk as other people think. In our opinion the team instability issue for an established top-tier fund is probably greater. However, with a new team we expect to see people who have proven individual track records. When we see a new firm we want to see a couple of key people there who have trained at a great firm, done great deals at a great firm, and we need to know that they have the deal-making skills and the necessary operating/business-building experience.
What size of investments do you make?
Our bite sizes tend to range from $5m to $30m, for both venture capital and buy-outs. Occasionally we do what we call 'turn-key investments'. These are large commitments to sponsor new partnerships. These commitments can range from $75m to $150m but we do them very infrequently and very selectively.
How do you put together investment portfolios?
In those cases where we run an entire private equity portfolio for a client, we first talk to our client about the type of risk they want to take, the exposure that they want to have and then work with them to build 'modelled portfolios'. In other cases we manage a piece of a client's portfolio such as a high value-added component. For a couple of clients we look at the smaller end of the venture and the buy-out markets.
To create the modelled portfolio we do not only state that we want to spend this much into early-stage venture, this much into late-stage venture, this much into buy-out and that much into technology, we also put fund names against it. We do that because we do not want to view the fund selection as a beauty contest, where a fund manager walks through the door and you say 'yes' or 'no'. We want to take a snapshot of the entire market over the life of the client's portfolio and put the money into the best funds in each sector and segment. We do not want to pick a good biotech fund today if we know that there is a fabulous one coming out in two years' time.
In what way do you differentiate yourself from other fund of funds managers?
Grove Street was created by people with operating experience in private equity. Clint Harris, for example, a managing partner and one of the founders of our firm, was previously a managing director and one of the founders of Advent. He sat on Advent's investment committee, did deals, ran programmes and started affiliated funds. We believe that this kind of experience is essential to do in-depth due diligence on people.
One of the things that also makes us a little bit different in our approach is that we have senior partner involvement from the beginning. Often fund of funds and gatekeepers have junior people doing the screening of funds. We have senior people involved in the screening because to us it is important to have senior people involved at all stages of the due diligence. Junior people who come straight out of business school cannot always see the diamonds and cannot always quickly identify the opportunity or key issues that face a fund manager.
I think that in the new and emerging space, for example, you really have to know who the people are, and having 20 years of experience helps you make a judgement on whether a new fund will be successful. Or when you do reference checks, you really need to do them with independent people and you should do them with people who you have known over a long period of time and with whom you have a relationship of trust. A junior person does not have those kinds of relationships.
What is important in your due diligence?
We do our reference checks early on in the process, while many people do them at the end. The reason for that is that if we get bad reference checks we do not want to proceed.
In contrast to other investors we do not use questionnaires. We probably ask the same questions but we do it face-to-face. Firstly, we want to focus our time on the most important issues first, and secondly, we do not want to waste the general partners' time. We do not want to make them fill out huge amounts of paper when we might not be that interested in carrying out the transaction. What we always aim at is managing our process very effectively and efficiently. As access is often an issue, we do not want processes getting in the way of getting into a great fund. The questionnaire approach takes too long and a fund manager may not be particularly compelled to fill it out if he is already three or four times oversubscribed.
We try to identify very early in the process what the most critical issues are with respect to a particular fund, and those issues are different for every fund. Sometimes there are organisational issues, issues concerning who is actively investing the fund versus who has built the track record or issues on succession planning or compensation. Only after we have identified the fund-specific issues we complete a full due diligence.
When you analyse the track record of a group you obviously want to know how well they did with their realised track records. Did they create successful companies? However, often track records get dated or they are for strategies or approaches that may not work in the current environment or people who were responsible for the track record are no longer active in firm. When you look at the bubble track record, some of that is irrelevant to the current environment. That is why we put a huge amount of emphasis on taking a close look at the general partners' unrealised portfolios. We bring to bear our own experience in doing deals and looking at portfolio companies: Are they on track with their business plan? Are they meeting expectations? Are they being valued properly?
What are the most important characteristics of a good fund manager?
We look for experienced private equity professionals who have built great personal track records. We look more at the individual than the firm because people at firms change. Business-building skills are essential and so is that the general partners can add real value to their portfolio companies. Stability within the organisation is another key factor for us.
How do you find out about good funds?
In total we currently invest with about 100 general partners. With our experience and our relationships in private equity we know the people and the funds generally pretty well. On the new and emerging side we are constantly looking for interesting new teams. Our networks help us identify the best funds and find out early about people leaving firms and starting new firms.
What are the biggest issues in private equity?
We are seeing a significant generational shift occurring at many private equity firms, and how they handle that issue is fairly important. We often spend a lot of time assessing the economics within a firm - how compensation is being paid, what the succession plan is, how people are expected to move up in their careers, who is working/who is not working? - because these are often the issues that tear firms apart.
Another current issue is that in buy-outs, historically most of the great firms earlier on were built by investment bankers and the skills for success were financial engineering and deal-making skills, whereas today it is the ability to enhance the operational performance of a company that will drive returns. That is a major strategy shift.
An issue in venture capital is that some venture capitalists have good experience but their experience is in a technology of the past.
What are Grove Street's investment plans for 2005?
We are currently working at a pace of 40 investments/$500m a year across venture and buy-outs. Our pace has picked up significantly in 2004 and 2005 because most of the venture capital partnerships are raising capital. The venture industry pretty much got into fundraising synch in 1999/2000. Of course, buy-out funds did not get into 'fundraising synch' and we are seeing a more normal pace of commitments. A more normalised pace for us is 25 to 30 commitments per year or about $350m.
What advice would you give to a new private equity investor?
To be in the asset class you want to be in the true top-quartile funds because by and large medium performance does not beat the public market indexes. The problem is that there is only a small number of funds that have outstanding performance. You have to find a way to access the best funds.
Hire people with experience. I am often amazed when firms appoint inexperienced people to run a private equity portfolio. Having done both investments directly in companies and investments in funds I actually think that fund investing is a lot harder because essentially what you are doing is hiring a group of senior executives who you cannot fire for ten years.
What irritates you about private equity?
Besides the huge amount of money coming into the asset class, it irritates me that there are no good benchmarks and indexes for the asset class and that some investors focus more on relative returns than on total returns. Historically this has been a total-return asset class where people look for absolute cash-on-cash multiples. As a lot of institutional investors have come in they are looking for relative returns and they are very happy if they can beat the public market index by a couple of a hundred basis points. That mentality is attracting a lot of capital to the asset class. I am also concerned about the push for greater market to market accounting. In public markets and mergers and acquisitions, prices are set by independent parties. I worry that general partners are not sufficiently independent to value their own portfolios for accounting purposes and that their accountants do not have sufficient data or skills to opine whether the valuations are appropriate. I also worry that there is potential for wide variations in valuation approaches that may distort the ability to compare one general partner's performance to another or to the published indexes.
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