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NCPERS 2013 Annual Conference & Exhibition CALIFORNIA MASSACHUSETTS NEW YORK 4365 Executive Drive 222 Rosewood Drive 140 Broadway Suite 900 3rd Floor 46th Floor San Diego, CA 92121 Danvers, MA 01923 New York, NY 10005 (Unstaffed, satellite office) NCPERS 2013 Annual Conference & Exhibition What Investors Should Know About Fees and How to Approach Them in Today’s Market David Fann, President + CEO May 2013 WWW.TORREYCOVE.COM © 2013 TorreyCove Capital Partners │ Confidential Information PRIVATE EQUITY OUTPERFORMS 10‐Year Returns 10.91% 10 Private equity has 9 8.43% significantly out- 7.67% 8 performed real 6.75% estate, public 7 equities and fixed 6 income over the past 5 10 years, thereby 4 easing pressure on 3 the returns of 1.88% institutional 2 investors. 1 0 Private Equity Real Estate Fixed Income Public Equity Cash Sources: Thompson Reuters 10-year Pooled Horizon Returns as of 12/31/12 (All non-VC Global Private Equity); NCREIF Property Index 10-year return as of 12/31/12; HFRI RV: Fixed Income-Corporate Index 10-year total return as of 12/31/12; Russell 3000 Total Return Index 10-year return as of 12/31/12 USD; 10-year Total Return Money Market Index as of 12/31/12. © 2013 TorreyCove Capital Partners │ Confidential Information 2 WHAT DOES TORREYCOVE DATA TELL US? 1. Examined a sample of over 400 funds dating from 1993 2. Divided funds into three return groups (terciles) and compared average management fees 3. Then, correlated to performance CONCLUSIONS • Result was counterintuitive: better performing funds had lower fees • Does not mean that you should select funds based solely on fees • Fees are important, but secondary to selecting the top tier of managers and sound portfolio construction FIGURE 1: FIGURE 2: Fee Versus Performance by Return Group Fee Versus Performance by Management Fee Group Low Tercile Mid Tercile High Tercile Low Tercile Mid Tercile High Tercile Avg. Return ‐8.64% 9.33% 25.70% Mgmt. Fee =/<1.5% 1.5<X>2.0% =/>2.0% Mgmt. Fee 1.760% 1.723% 1.677% Avg. Return 12.2651% 5.8314% 5.6436% Source: TorreyCove Research Source: TorreyCove Research © 2013 TorreyCove Capital Partners │ Confidential Information 3 IMPLICATIONS • On average, larger funds appear to perform better • Possible explanations: o Larger funds generally have lower fees. Successful funds tend to have gotten larger and tend to charge lower percentage management fees as they grow. o Larger funds have more resources. o Persistence. Top tercile funds tend to stay top tercile. Figure 3: Data Characteristics Figure 4: Tercile Analysis Type Average Average Average Returns by Fee Tercile Average Fund Size by Fee Tercile Fee Return Size ($M) VC & Growth 9 VC & Growth Venture 20 Small & Middle 18 8 Small & Middle Capital & Large 16 7 Large Growth 2.12% 9.92% 517 14 6 ($b) 12 5 Small & 10 Size 4 Returns 8 Middle 1.88% 9.79% 1,268 3 6 Fund 4 2 2 1 Large 1.45% 10.60% 6,002 0 Low Middle High Low Middle High Source: TorreyCove Research Source: TorreyCove Research © 2013 TorreyCove Capital Partners │ Confidential Information 4 TOO MANY FUNDS IN MARKET ‐ RETURNS DECLINING Global Buyout/Growth Funds' Net IRR 500 Historical Fundraising (Buyout & Growth Funds) (Inception to Date by VY) 35% Cumulative target 400 fund size of funds 30% currently in market 302 25% 300 262 262 20% 236 200 15% 153 123 113 10% 103 99 109 100 76 62 66 5% 45 0% 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Top Quartile Median Bottom Quartile Aggregate Capital Raised (bn USD) No. of Funds Source: Preqin Source: Preqin Why too many? • Explosion of fundraising in years leading up to crisis • Increasing concentration of institutional portfolios “Zombie Funds” are increasing • Poor post‐crisis performance © 2013 TorreyCove Capital Partners │ Confidential Information 5 FUND OF FUNDS MODEL UNDER PRESSURE As the expected returns for traditional leveraged buyouts have come down to the low‐to‐mid teens, fund‐of‐funds fee drag is becoming harder to justify. Market Conditions & Competitive PE Landscape has Fund-of-Funds IRR Erosion Is Close to 20% at the Caused Actual & Expected PE Returns to Come Down Levels of Expected Leveraged Buyout Returns Upper and Top Quartile LBO Weighted IRR 1 Net IRR at Expected Net IRR Fee Drag 35% 34% the Fund Level at the FOF Level 2 Proportion 29% 30% 40.0% 35.7% 12.0% 25% 35.0% 31.1% 12.7% 25% 24% 30.0% 26.6% 12.8% 20% 19% 18% 25.0% 21.8% 14.5% 16% 15% 20.0% 17.1% 16.9% 13% 10% 15.0% 12.5% 19.8% 10% 10.0% 7.9% 26.9% 5% 2001 2002 2003 2004 2005 2006 2007 2008 2009 5.0% 3.5% 41.8% 1 Preqin data for all buyout funds as of the latest available report date (3/4/2013). 2 Assumes 5-year commitment period; 1% MF on committed capital during commitment period, 0.75% MF on remaining investments. Capital thereafter; 10% carry; relatively quick deployment of capital on the underlying fund investment level (conservative approach, as slower utilization of capital will lead to an even greater IRR erosion). © 2013 TorreyCove Capital Partners │ Confidential Information 6 OPPORTUNITIES TO IMPROVE PERFORMANCE IN A LOWER‐RETURN ENVIRONMENT • Tactics to consider • Be more selective in building direct relationships with best managers • “Transform” solid second quartile funds into top quartile performers via reduced fee structure ‐‐ requires negotiation • Seed promising emerging managers in return for better potential upside and significantly reduced fees • Reduce fee drag by shifting to separate accounts or other approaches © 2013 TorreyCove Capital Partners │ Confidential Information 7 CASE STUDY: FUND X Skilled Team Coming Together on a Formidable Strategic Platform • Founded by seasoned PE • Firm X, the global leader in creating and implementing solutions for companies executives with the facing turmoil, had yet to build a private equity platform, until... backing of Firm X. • The Fund was established by a team of experienced partners with the deal • $500 million target. sourcing and operational resources of Firm X at its fingertips. • When TorreyCove reviewed the opportunity, there were two existing anchor • Middle market investors which had sponsored the fund from the beginning. Each had been investments which rightfully recognized for their support. can benefit from the • TorreyCove worked with the Fund to fine tune alignment of interests between expertise and our client and the firm within the fund’s existing framework. resources of its strategic affiliate. • The result was a balance of uniquely attractive terms for the fund’s largest limited partner (1% management fee and 10% carry) combined with the prospect for the Fund of stable capital beyond its inaugural fund. • The collaboration is intended to be a dynamic, fluid and ongoing effort to ensure governing terms are beneficial for all parties involved. © 2013 TorreyCove Capital Partners │ Confidential Information 8 Invesco Private Capital – The Case for Smaller Private Equity and Venture Capital Funds National Conference on Public Employee Retirement Systems Presented by: Henry Robin, General Partner The Case for Why Smaller Can Be Better… Private Equity and Venture Capital Returns Have Declined Over the Past Decade • An abundance of capital has led to style drift and funding of sub-par investments • Private equity is not scalable to the same extent as public equities Venture Economics All Private Equity Assets Under Management vs. Performance Assets Under Management ($B) Rolling 5-Year Returns $1,104 $1,033 $1,010 $994 $957 28.3% $883 $679 $590 $552 $507 $515 $499 13.8% $408 $281 $204 $157 $114 $138 3.7% $78 $82 $86 $97 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: Thomson Venture Economics, Global All Private Equity Index assets under management and rolling five year performance by year as of 12/31/11. Past performance does not guarantee future results. Capital Raised is Clustered in Larger Funds Over half of the private equity and venture capital commitments raised since 2000 has been to funds of over $1 billion in size • Incentives can shift from carry distributions based on investment returns to steady-stream income from annual management fees • Incentive to gather more assets can result in lowering the bar on return expectations fro executed deals Venture Economics All Private Equity Fundraising By Fund Size $1,561 Funds Raised Since 2000 ($B) $447 $351 $291 $183 < $100M $100M - $300M $300M - $500M $500M - $1B > $1B Source: Thomson Venture Economics, global private equity fundraising from 01/01/00 through 6/30/12, excluding Real Estate, Fund-of- Funds and Non-Private Equity. 4 Buyout Fund Performance Varies by Fund Size In fact, the data supports the conclusion that larger funds historically under- perform smaller funds Venture Economics Buyout Index Pooled Average IRR by Fund Type 15.7% 15.0% 14.2% 9.3% Small Buyout Medium Buyout Large Buyout Mega Buyout (<$250M) ($250M - $500M) ($500M - $1B) (>$1B) Source: Thomson Venture Economics All Private Equity Index (all vintage years) as of 9/30/12. US buyout funds only. Past performance is not a guarantee of future results. Venture Fund Performance Shows a Similar Size Discrepancy Attractive venture-like returns are predominately found in smaller funds, particularly those focused on early stage investing Venture Economics Venture Capital Index Pooled Average IRR by Fund Size Early Stage Later Stage Balanced 22.3% 17.4% 17.8% 16.0% 15.0% 14.2% 7.8% 4.6% -1.1% -0.1% 1.1% $100 - $300M $300 - $500M $500M - $1B 0.9% >$1B Source: Thomson Venture Economics All Venture Capital Equity Index (all vintage years) as of 9/30/12.
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