What is the basic approach to managing the fund?
The fund is a private equity fund of funds with a significant element of coinvestments. The primary aim is to deliver the strong returns that private equity is known for ( well ahead of what could be achieved in the stockmarket over the medium and longer term) but to do so at only moderate levels of risk. The lower risk profile is achieved principally through diversification. Whilst our portfolio is largely invested in European mid market buy-outs, it is well diversified by manager, geography, sector, size (within the mid market range), vintage year and investment style. We have exposure to over 300 companies through the funds and coinvestments in the portfolio. Within the European mid market we have a preference for backing ‘emerging managers’, which we define as management groups within their first three funds. This is all about identifying well motivated, capabale teams with the skillsets to perform well over the medium term.
What market conditions are most beneficial to your fund?
Private Equity managers have proven themselves capable of making excellent returns irrespective of overall market conditions. The portfolio of private equity managers is not a general proxy for the market but is rather a focused selection of generally fast growing and well managed companies where there is a distinct thesis behind that growth continuing. It follows that good returns can be made even when background conditions are tough. That said an expanding background economy and particularly one where confidence is improving is usually beneficial. This is the case at present. Other specific factors that help include an improvement in the availability of bank debt, which is a key component of any management buy-out. Again this is improving currently.
What fund selections have been the most successful and unsuccessful over the past twelve months?
The nature of private equity is that there is a long time lag between an investment being made and being sure of the ultimate success of that investment. In any given year there are investments which contribute to or detract from performance – sometimes this is the final position, if for example a coinvestment has exited completely, but often it is an interim assessment based upon the valuation changes, based on the fundamental progress, over the year. During 2013 the main positive contributors included the following:
- One of our main venture capital holdings, SEP III, was uplifted over the year, principally to reflect the good progress of Skyscanner, by £7.7 million.
- Stirling Square Capital Partners II was uplifted by £1.8 million following good trading in several holdings.
- Primary Capital III benefited from strong trading in several holdings and was up by £1.7 million.
- Life Science Partners III was up by £1.3 million largely because of the successful exit of Okairos (T- cell vaccines) to GlaxoSmithKline.
- 3SI is trading well and was up by £1.0 million as was Harrington Brooks.
- Warburg Pincus IX, RJD Partners II and N+1 Private Equity II were up by £1.0 million, in each case reflecting a number of individual uplifts and exits.
The main detractors were as follows;
- Axitea, the Italian security company, continues to face trading difficulties occasioned, at least in part, by poor payment practices of municipal authorities and this holding has been reduced to nil, a downgrade of £3.5 million.
- Whittan, the pallet racking systems company, has been hit by slowing orders from major customers and this has been reduced by £1.8 million.
What will be the most influential factors for the private equity sector over the next year?
There is a clear improvement in confidence levels within the international private equity market and within the wider M&A market. This is likely to lead to a noticeable increase in deal activity in the private equity sector. This will increase the number of exits and the associated uplifts in value that accompanies them. The main caveat is that confidence can be knocked by external events and shocks, which have been fairly common in recent years. In that respect private equity is subject to similar influences to the wider market.
What do you expect to be the biggest challenges for the fund over the next few years?
Our main challenge is to maintain a fully invested high quality portfolio that is sufficiently well diversified that it always has a good proportion of investments maturing during any given year. This involves continually thinking ahead and sowing the seeds for capital appreciation some years in the future. That said there are times when the market is more attractive than others. Our view is that we are currently in a buying opportunity and we would like to invest as much as possible over the next two years or so without over stretching the company’s balance sheet. This is a balancing act, but one which we are familiar with.