Premium Content Exclusively for Privcap Subscribers Only / www.privcap.com PRIVCAP / Q1 2014 SPECIAL REPORTS Performance The 2004 Vintage, 10 Years Out IRRs & Bad Management Co- with Siguler Gu, Cambridge Associates & StepStone Portfolio One-on-one with Protección, Colombia’s second-largest pension Performance Equity Zurich Alternative Sovereign Investor Institute & finish On Privcap.c0m Videos in This Report

This special report includes the following new video On Camera programs. Watch them at Privcap.com What the Sovereign Wealth Funds Want Sovereign Investor Institute’s Scott Kalb says the $6 trillion SWF sector wants more than returns from its GPs.

Tips for Selecting a Quality GP Manager Frank Brenninkmeyer of Performance Equity on what his firm seeks in a GP manager and its history with GM’s pension group.

Creating a PE Portfolio Omar Rueda Galvis of Colombia’s ProtecciÓn talks about his group’s entry into the PE market, dealing with foreign and local GPs, and where their focus lies in 2014. Andrea Auerbach, Cambridge Associates An Group Wagers on More PE Ferdinand Seibert of Zurich Alternative dis- cusses PE’s role in a portfolio, the effects of regulation, and how to differentiate GP operating skills.

Ardian Is the New Vladimir Colas of Ardian describes the firm’s move to indepen- dence, its European middle-market roots, and its approach to primary and co-investing.

How’s the 2004 Vintage Looking? What do we know about the average performance of PE funds in the 2004 vintage? With experts from StepStone, Cambridge Associ- ates, and Siguler Guff.

Fund-Management Mistakes That Shave Off IRR Points “Deal guys” don’t always consider performance optimization of their fund, making mistakes that shave off IRR points. With experts from Cambridge Associates, StepStone, and Siguler Guff.

Adding Alpha Through Co-investing A deep dive into Siguler Guff’s co-investment platform—how it helped the firm add alpha to its portfolio. Experts from Cambridge Associates and StepStone weigh in.

COMING SOON on Privcap UPCOMING REPORTS

Colombia’s Growing Appetite for PE PE’s Influences in Colombia Q2 Francisco Jose Arboleda of HarbourVest Alejandro Rodriguez of PineBridge Invest- Co-investment Partners talks about in ments speaks with Privcap about private Energy Colombia, and the growth of the industry equity’s impact in Colombia, the country’s and talent in the country. pensions, and local and regional offices.

On Privcap.com

In Case You Missed It... Must-see thought leadership from Privcap.com

KKR and Its Capital Partners CFOs Navigate the Headwinds Forklift to the Future: Suzanne Donohoe, who leads investor Scott Zimmerman of EY discusses the KKR’s Investment in KION relations for KKR, describes the evolving results of a survey of PE firm CFOs. Johannes Huth of KKR describes the needs of the firm’s institutional Despite regulatory and business thesis behind the firm’s successful investors clients. challenges, these team members are investment in KION, a German maker optimistic about the futures of their of forklifts and other industrial trucks. firms as they gear up for growth.

From Defined Benefit to How Much Does a Profits, Impact, and Defined Contribution Fundraising Cost? Energy Efficiency The shift from defined-benefit to Three PE leaders discuss how much a GP Carter Bales and former NY State first defined-contribution plans in the U.S. should expect to spend raising a fund. lady Silda Wall Spitzer discuss the is inevitable—and it’s happening faster With Gene Wolfson of Catalyst Investors, investment strategy of their firm, than expected, says George Pandaleon Adam Blumenthal of Blue Wolf Capital NewWorld Capital Group, which backs of Inland Institutional Capital Partners. Partners, and Mounir Guen of MVision. companies fighting energy waste.

About Privcap Special Reports Privcap Special Reports are exclusively for subscribers to Privcap, the definitive channel for thought leadership in private capital. Each month Privcap focuses on a critical theme and produces a “bundle” of thought-leadership content in multiple formats – a digital report, video interviews and panel discussions, and audio programs. We capture the market intelligence of leading authorities, whose expertise forms the core of each report. Privcap Special Reports help market participants better understand opportunities and practices in private capital, as well as gain deep insights into the people with whom they may become long-term investment partners. PRIVCAP 19 07 SPECIAL REPORTS finish

In This Issue 2 0 Commentary 05 The long-term view required of private equity inves- 1 tors has its challenges and rewards, says Privcap CEO 4 David Snow.

What Colombia’s Second-Largest LP 07 Wants Omar Rueda Galvis of Colombia’s Proteccion discusses the genesis of their PE program and why they want to invest with fewer GPs. PE Performance 26 07 10 Panelists from Siguler Guff, Cambridge Associates, and StepStone Group on co-investment rewards and risk, performance of the 2004 vintage, and missteps that 19 can shave off IRR points. Also: a look at Brazil’s PE funds.

◆Making Co-investment Work ◆Maximizing IRR PRIVCAP SPECIAL REPORTS ◆The 2004 Vintage Plus: Brazil Funds Gaining Strength Privcap Media David Snow Co-founder and CEO Gill Torren Co-founder and President Four LPs Talk Portfolio Matthew Malone Editorial Director 17 Privcap contributing editor Tom Franco talks with Content thought leaders from the LP community about PE in the Ainslie Chandler Senior Journalist portfolio, and the future of the asset class. Andrea Heisinger Associate Editor Kathleen O’Donnell Media Coordinator ◆Ardian’s Independence Day, with Vladimir Colas Cameron Faulkner Media Coordinator of Ardian Design ◆A Global Insurance Group’s Bet on PE, with Ferdinand Cecilia Salama Design Coordinator Seibert of Zurich Alternative Contributors ◆Breaking Down GP Manager Selection, with Frank Tom Stein Brenninkmeyer of Performance Equity Contacts

◆What Sovereign Funds Want in a GP, with Scott Kalb Editorial of Sovereign Investor Institute David Snow / [email protected] / 646.233.4558

From the Archives Matthew Malone / 21 Related content from Privcap.com [email protected] / 203.554.7261 Sponsorships & Sales From Our Sponsors Gill Torren / 22 Thought leadership from our sponsor: [email protected] / 646.233.4559 Gen II For subscriptions, please call 855-PRIVCAP or email [email protected] Copyright © 2014 by Privcap LLC

Interviews in this report have been edited for length and clarity. PE PERFORMANCE AND PORTFOLIO / COMMENTARY Low-Frequency Trading The private equity asset class is both blessed and challenged by its very long holding periods

f the stock market has a millisecond prob- you put into a private equity investment and how lem, private equity has a problem measured many you’ve gotten back. In this report, three ex- in decades. perts—Andrea Auerbach of Cambridge Associates, Mike Elio of StepStone, and Kevin Kester of Sigul- Among its many revelations, Michael Lewis’ er Guff—examine the DPI of private equity funds new book, “Flash Boys,” highlights the mind-bog- launched in 2004. As of Cambridge’s last measure- gling complexity of a mature, traded, technolo- ment date, the 2004 vintage funds have an average gy-dependent asset class. The U. S. stock market DPI of 1.02. That’s well behind typical distributions has moved so far beyond its origins in human bar- from funds entering their second decade. We can, tering that it now has been taken over by comput- perhaps, blame the lag on the Great Recession, dur- ers that snatch value out of the market in between ing which exits were few. But as our gathered ex- millisecond trade matches. perts point out, private equity fundraising rose all the way through 2008. Therefore, a huge amount Compare this bewildering state of affairs to the less of private equity’s hoped-for outperformance re- mature, less traded, and technologically underpen- mains trapped in a collection of portfolio compa- Market etrated private equity market. People aren’t kid- nies of unprecedented aggregate size. As Elio puts Analysis by ding when they say private equity is a long-term it, “If all your gain is still tied up, we have so many CEO asset class. You could commit capital to a private assets to liquidate, it’s going to be difficult.” David Snow equity fund, raise your kids and send them off to college before getting back the full value of your Secondary “Flash Boys” investment in cash. Perhaps this is as it should It’s clear that new participants in the private eq- be—left to your own fickle decision-making over uity asset class, armed with decades of such per- that roughly 15-year time horizon, you might have formance data, should know what they’re signing stopped investing and missed the prime buying up for—GP relationships that will span well be- opportunity, desperately sold your best assets in yond the advertised 10-year life of the individu- mid-recession, or blown the whole allocation at al funds. Investors still concerned about liquidity the top of the market. should also note the increasing size and dexterity of the private equity secondaries market, in which Instead, you paid a GP to laboriously deploy the opportunities to trade in and out of partnerships capital over a four-or five-year period, and then re- are not quite at “Flash Boys” levels, but are signif- main long-term greedy in deciding when and how icantly more technologically advanced than even to exit those . Sell that struggling con- five years ago. sumer business in 2010 just because LPs were com- plaining about needing liquidity? No way. Better to Driving liquidity in the private equity market is the wait it out. That’s called control and optionality. If removal of what was one the main impediment to you need liquidity, sell off your stock portfolio. secondaries dealmaking: shame. GPs used to find it embarrassing when LPs wanted out of a fund. To- In this special report on performance and portfo- day, this request to trade is now widely accepted lio management, one of the related measures we and, in many cases, welcomed as an opportunity to examine is DPI, or distributed-to-paid-in capi- forge a relationship with a new investor. tal. That’s the ratio between how many dollars Evidence exists that another psychological barrier IF THE STOCK MARKET HAS A MILLISECOND to secondaries deal-doing is also fading—the stig- PROBLEM, PRIVATE EQUITY HAS A PROBLEM ma of NAV pricing. In the public market, partici- MEASURED IN DECADES. pants have so many varying views and goals that “ Privcap“ Special Report •PE Performance and Portfolio | Q2 2014 / 5 PE PERFORMANCE AND PORTFOLIO / COMMENTARY a stock can find itself priced very differently fund-level NAV. Indeed, a recent study con- over the course of an economic cycle. What’s ducted by Pantheon’s Rudy Scarpa found that the right price-to-earnings ratio for General the performance of the firm’s secondaries pro- Electric? It depends on facts specific to GE and gram had little to do with the depth of discount the markets it serves, about which many smart paid for a bundle of fund interests. Scarpa ar- people have different views. gues that buyers who focus solely on large dis- counts to NAV may be encouraging the wrong In private equity secondaries land, by contrast, kind of deal skills. there has historically been a singular focus on pricing around NAV. As in, “Did you pay a pre- Increasingly, technology is helping more PE mium to NAV or a discount to NAV?” The more market participants make better decisions a market participant regards NAV as the “true” around secondaries deals. Platforms that link value of a partnership interest, the more like- portfolio data all the way up to limited partners ly they are to believe that buyers are winning and their advisors bring the asset class a smid- if they scoop up a discount and sellers are win- gen closer to the symmetry of information that ning if they command a premium. In lieu of the public market is supposed to provide (re- more and better information, NAV pricing is peat—supposed to). the most important scoreboard. Countless sec- ondaries deals have fallen apart over NAV. It will be a long time before private equity’s inefficiencies are arbitraged in milliseconds But the NAV is a number assigned by the GP and decimals. In the meantime, advances in to a collection of private portfolio companies liquidity should bring comfort to those who are that, while striving for fair value, can credi- shocked to discover that the dollar they put in bly vary widely based on the methodology and 10 years ago is only now available in full, and outlook of the team doing the valuation. The who may look longingly at the stock market as best secondaries investors take a view on un- an easier, more predictable place to invest./ derlying portfolio company valuations, not

Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 6 PE PERFORMANCE AND PORTFOLIO / INVESTOR PROFILE

Click to watch this video at privcap.com What Colombia’s Second-Largest LP Wants More private equity and fewer GPs, says its head of investing ProtecciÓn also recently became a co-inves- tor, alongside , in Ole- oducto Central, Colombia’s largest crude oil transportation system.

In a February interview with Privcap, Rueda Galvis discussed the genesis of ProtecciÓn’s private equity program, the regulatory limits of its allocation policy, and what GPs need to know before they try to book a meeting with him.

Privcap Why in 2010 did your organization begin allocating to private equity?

Rueda Galvis We were looking for exposure to different as- set classes. So we decided in 2005 to have a relationship with funds of funds in the inter- Omar Rueda Galvis, ProtecciÓn national world.

mar Rueda Galvis, vice presi- They make precise determinations of what dent of investments for Colombi- the future runoff of that fund is going to be an ProtecciÓn, says and invest in interest-bearing securities. that private equity plays a vital Once one or two of the big states or municipal role in the overall portfolio. plans goes in this direction, it’s a domino effect. Illinois may be one of the first ones, Rueda Galvis’ views are important for any pri- because they have the biggest problem. vate equity firm to understand. Colombia has become an important new destination on the For Colombian pensions, we have different fundraising trail because of the growth, so- limits for local private equity and for offshore phistication and international focus of its lo- private equity. In both cases, we have a “five” cal institutional investors. ProtecciÓn is the limit—five percent for local private equity and second-largest pension fund in the country, five percent for international. with some $27 billion in assets under man- agement and a roughly 10 percent allocation In 2005—as soon as the regulator allowed to private equity. The pension commits capi- us to invest in this asset class—we started tal to established international groups and is to have conversations with funds of funds in nurturing a generation of local GPs. the international markets. That was the way

Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 7 PE PERFORMANCE AND PORTFOLIO / INVESTOR PROFILE to tried to learn about private equity. At the lower exposure to emerging markets because same time, we supported the idea to create Colombia is an emerging market. the private equity industry in Colombia. In other words, we were looking for good teams Privcap to manage the money for us. Are you working with the local market to en- courage further development of private equi- At the beginning of 2008, before the bubble, ty firms? we decided to have more exposure to sec- ondary portfolios and . We started Rueda Galvis to speak with another kind of GP—the well- We want to “copy” the standards that the in- known names like Blackstone, KKR, Lexing- ternational GPs have—we want the local GPs ton, . We were also working on to have the same kind of standards. We have the idea of having private local funds. found that at the beginning of the process with the local private equity firms, we have a That was so difficult, because when we start- lot of issues about the information that they ed to compare the experience of the interna- give us as investors. tional teams with the Colombian teams, we recognized we have a huge gap. We realized In Colombia, the GPs decided to have the we were going to have more risk with these same as the international local funds than the international funds. GPs. In the international market, you can see a track record. Here there is no track record. We learned a lot. We developed an in-house due diligence process to pick the best manag- The challenge that we have right now is that ers and decided to create a team focused on private equity is important in our asset allo- legal, risk, and investment areas. cation. We are close to the maximum limit of 5 percent. So now we have to have anoth- Privcap er conversation with our regulators and try What role does private equity play in Protec- to show them how important it is for us to ciÓn’s overall portfolio? have exposure to alternative investments. We would like to increase this limit—maybe 5 Rueda Galvis percent more. The reasons [for private equity] have to do with the target replacement rates of our af- Privcap filiates. That means that in creating our asset Colombia has become a popular place not allocation, we must have a really good port- only to deploy private equity capital, but from folio that is going to give a really good return which to raise capital. What should an inter- over a long time horizon, with the idea to national GP know about your program before have a replacement rate around 17 percent. trying to set up a meeting? We started to see a lot of problems trying to get this higher return. So there is one way to Rueda Galvis try to get a lot of exposure to equity, and it’s Before we have any kind of meeting with a through private equity. GP, at the beginning of every year we have our asset allocation where we ask what kind Privcap of strategy we should focus on in the private Please paint a picture of the private equity equity program. For example, [we decide] if portfolio that ProtecciÓn has built to date. we would like buyouts, or secondaries, or the mid-market. This year, we believe buyouts are Rueda Galvis not the best idea. The market is expensive, so Normally when we want to invest in interna- we are thinking about other kinds of strate- tional private equity, we want exposure to the gies. lower end of the market. We are looking for GPs with these kinds of strategies. Around 50 In 2005 we started to build the private equity percent of our portfolio is focused on the Unit- program. Right now we have too many GPs in ed States and the rest is global, meaning Eu- the portfolio. So we are in the process of try- rope, Japan, Asia, and a little bit of emerging ing to cut to a minimum number and work markets, especially Latin America. We have with them./

Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 8 PE PERFORMANCE Panelists from Siguler Guff, Cambridge Associates, and StepStone Group on co-investment rewards and risk, performance of 2004 vintage, and fund-management missteps that can shave off points. We also take a look at Brazil’s PE funds.

finish

Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 9 PE PERFORMANCE AND PORTFOLIO / PERFORMANCE

Click to watch this video at privcap.com

The 2004 Vintage

Situated several years before a massive downturn, vintage-year 2004 is—unsurprisingly—a lackluster performer. But our experts say LPs exposed to the 2004 vintage did well compared to other asset classes.

or investors in funds launched in 2004, pressed by the respectable showing of funds in the the big performance news is this: for that lower quartile. “Those funds had an average net year at least, the notion that picking the IRR around 7 percent, which pretty much beats right GP is essential to performance fell half the years since 1986,” says Elio. flat on its face. Strategy selection clearly Overall, Kester says, it’s important to assess a vin- won the day. tage year within a broader context. In 2004, for in- stance, the economy was emerging from the dot- Data from Cambridge Associates peg the pooled av- com crash. erage net IRR for the 2004 vintage at 11 percent; that’s at the low end of 10-year pooled performance “Looking at the numbers, what we see is some cor- numbers for funds launched in the preceding dec- relation between coming out of recessionary peri- ade. But there is a strikingly narrow spread be- ods and funds formed at the peak of the market, tween returns of top-and lower-quartile funds. The versus the bottom of the market,” says Kester. “In top-quartile averaged 14 percent IRRs, versus sev- 2004, you’re on an upswing. You’re starting to get en percent for the lower-quartile. That seven per- loftier valuations, loftier entry multiples, and lev- centage point difference is by far the smallest mar- erage is starting to come back. So we’re likely to see gin in relative performance among funds launched ’04 look more like 2012, 2013, or even where we are from 1994-2004. For example, top-quartile funds today.” from 2001 returned 36 percent; the lowest-quartile returned 10 percent. Further breaking down the 2004 data, it becomes clear that certain strategies greatly outperformed The 2004 numbers surprise Kevin Kester, a manag- others. Perhaps the biggest winners were energy ing director at Siguler Guff, “I would have thought funds, which boasted an average performance of that some managers in that 2004 vintage would 19.49 percent. Are managers of these funds smarter have quickly invested their capital in ’04 and ’05 or were they just lucky? and been able to exit or recap businesses in ’06, ’07 and early ’08 and generate higher IRRs at the up- “The energy space in the mid-2000s just boomed,” per-quartile level,” Kester says. Elio says. “There are very few funds that I’ve seen go ‘full cycle,’ but there are a few energy funds that in- The 10-year mark is useful for drawing solid con- vested very quickly during that time period, exited clusions. “Most funds don’t really settle into their those investments fully, and now no longer exist. ultimate performance levels from an IRR perspec- So it was a good era.” tive for six to seven years,” says Andrea Auerbach, managing director and head of private investment By contrast, growth equity funds are the clear lag- research at Cambridge Associates. “Taking a look gards, with a scant 4.24 percent net IRR. “A lot of 10 years on, things should be settled in terms of growth equity managers may have been investing how it’s all going to end.” a tad more in venture-like investments as opposed to more classic growth equity as we’ve come to de- StepStone Group partner Michael Elio is more im- fine it today,” Auerbach explains. “So that could

Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 10 PE PERFORMANCE AND PORTFOLIO / PERFORMANCE

easily be a factor in the performance of the growth equity category within the ’04 benchmark.” Other notable performers were European EXPERT BIOS funds, which outpaced their U.S. competitors, re- turning around 13 percent, compared to 10.63 per- MICHAEL ELIO cent for U.S. funds. One of the most important statistics in private eq- Elio is a partner focusing on global investments uity, at least for limited partners, is the distribu- at StepStone Group. Prior to StepStone, he was tions to paid-in multiple. The DPI for the 2004 vin- a managing director at ILPA, where he led pro- tage year stands at 1.02 percent, which means that LPs are basically back to even. grams centered on research, standards, and industry-strategic priorities. “The average DPI from ’86 to ’04 is about 1.4 times,” Auerbach says. “So 2004 is pretty bad in terms of ANDREA AUERBACH getting your money back on a timely basis. But there’s still money on the table that we’re waiting Auerbach is a managing director at Cambridge to see.” Associates. She heads the U.S. private equity re- Kester believes the lingering effects of the last re- search team, which performs due diligence on in- cession may still be affecting the 2004 DPI. “For 12 vestment opportunities in private equity, mezza- to 18 months, there were a couple quarters where nine, and distressed markets. literally no deals were getting done,” he says. “That had to take its toll on that 2004 vintage. My guess KEVIN KESTER is that the duration of the 2004 is cer- tainly going to be longer.” Kester is a managing director at Siguler Guff and So what’s the takeaway for LPs? Should they con- a member of the investment committees for var- tinue to invest in an asset class where they put in a ious funds. He is a senior member of Siguler Guff’s dollar and 10 years later they get that dollar back? investment staff and oversees the firm’s Small That’s a long time to wait, even though there is cer- Buyout Opportunities Funds. tainly still value to be harvested in the 2004 port- folio.

“That’s part of the bargain to get those outsized re- turns,” Elio concludes. “That said, we’re in a much more mature market today, so I’m hoping that, with more liquidity in the public markets, we’ll get more liquidity in our market as well.”/

Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 11 PE PERFORMANCE AND PORTFOLIO / PERFORMANCE Ten Years In: 2004 Looks Like a Laggard A comparison of private equity fund vintage years, all measured rough- ly 10 years after their respective vintage years. For example, the 2001 vintage is as of Q2 2010. The private equity fund vintage year 2004 is as of Q2 2012. 2004 is among the weaker performers by this measurement.

Vintage Year Pooled Return (%) Upper Quartile (%) Lower Quartile (%) TVPI 2004 10.63 13.76 6.63 1.60 2003 16.17 17.78 7.24 1.73 2002 20.26 27.15 10.66 1.82 2001 24.12 35.83 10.22 1.88 1999 16.15 19.62 7.74 1.84 1998 8.40 16.56 6.22 1.45 1997 6.27 12.59 -0.20 1.32 1996 10.68 11.52 -0.93 1.49 1995 21.44 30.97 -0.14 1.92 1994 24.23 24.33 0.36 2.07 Source: Cambridge Associates 2004: Energy, Europe Stand Tall A comparison of the sub-strategies feeding into 2004’s overall PE performance shows an outperformance of energy funds and an un- derperformance by growth equity funds. At the bottom of the table is a comparison.

Vintage Year Pooled Return (%) Upper Quartile (%) Lower Quartile (%) TVPI All US PE 10.63 13.76 6.63 1.60 U.S. Buyouts 10.84 13.63 7.47 1.63 U.S. Growth Equity 4.24 NA NA 1.23 U.S. Mezzanine 5.94 NA NA 1.28 U.S. PE Energy 19.49 NA NA 1.72 Europe PE 13.05 19.45 9.02 1.63 Source: Cambridge Associates

Even Steven: 2004 Investors Get Their Principle Back Ten years after the formation of 2004 vintage PE funds, the funds are on average just beginning to return called capital back to investors, mean- ing a huge amount of unrealized value remains in the GPs’ portfolios. 2004 All US PE DPI* (arithmetic mean) 1.02 Source: Cambridge Associates

*What is the distributed to paid in (DPI) ratio? The proportion of “Called-down” capital that has been distributed back to LPs.

Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 12 PE PERFORMANCE AND PORTFOLIO / PERFORMANCE

Click to watch this video at privcap.com Making Co-investment Work

The popularity of co-investment—investing alongside managers rather than in their funds—is soaring. LPs want in on the action. One reason is the availability of low-fee and no-fee structures. Another is the chance for LPs to get better control of investments. But with reward comes risk.

Privcap Privcap It seems every LP in the world wants to co-in- Andrea, how does Cambridge track co-invest- vest alongside GPs. Why? ment?

Michael Elio, Partner, StepStone Group Andrea Auerbach, managing director and Surprisingly, lower fees are not the primary Head of U.S. Private Equity Research, Cam- driver. There are lower net fees in the long bridge Associates run, but LPs are looking to boost performance There are over 40 co-investment topic vehi- and get more control of where their dollars are cles we use to track co-investment as part of spent. It’s been difficult for them over the last our benchmarking. So we’re aware of how few years to get all the allocation they need discrete co-investment vehicles are perform- from some of the top-tier managers. Co-in- ing. And the trend of pursuing vestment is a way to control more money. 30 to 40 percent exposure in co-investment gives us another way to peel out performance. Privcap But the best benchmark is against the perfor- mance of private equity investments on a cal- Kevin, Siguler Guff has a fund of funds, but endar-year basis. you also invest alongside your own GPs as well as other GPs. How has that worked out? Privcap Kevin Kester, managing director, Siguler Guff So we know the benefits of co-investment if We co-invest up to 30 or 40 percent of a typ- things go right. What are some things that ical fund. The reason is selection. We believe can go wrong? we can pick very good opportunities on a deal- Elio by-deal basis. We have the resources and the talent, and we believe we can identify better Selection and execution. When you choose risk-reward opportunities. But we see a tre- a co-investment program, you’re building a mendous amount of deal flow, and to put to- portfolio on your own. That’s a new skill set. gether a successful co-investment program, And execution—if the GP calls, you need to be you have to see a lot of opportunities. there with the money. Kevin mentioned that Siguler Guff can do everything from A to Z. But most LPs, their process stops around P. In Privcap that kind of environment, you need to make Your co-investment portfolio has generated sure the execution happens. an IRR of 27.1 percent. Is that better than your fund IRR? Kester The risk is in not having a plan, not under- Kester standing what you’re investing in. We spend It is. We’ve added a significant amount of al- a lot of time with GPs to understand the dili- pha through our co-investment activities. gence they’ve done, but we come to our own Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 13 PE PERFORMANCE AND PORTFOLIO /

Panelists Michael Elio, Kevin Kester, and Andrea Auerbach

we were going to do, then the powers that be Siguler Guff Co-investment Facts may not like the volatility of my results, and then my program is at risk. Process risk is: Do •Has invested $1.2B in directs, $1.9B in co-investments you have it set up so you can rapidly address • Began direct investing in 1995, co-investing alongside GPs the opportunity, maintain your guidelines, in 2004 and complete and execute an investment? • Since 2007, has completed 58 co-investments via two And then, resource risk: There are a lot of in- Small Buyout Opportunities Funds stitutional investors who are armies of one or two, and a lot of their co-investments are fire • Siguler Guff’s Small Buyout Opportunities Fund I has posted 27 co-investments drills. You may get that last call and not have enough of a window to assess all the risks. • Those 27 co-investments have a portfolio-level IRR of 27.1% And lastly, there’s relationship risk: If I keep politely declining or if I’m not being respon- sive, I may not get the widest funnel of op- portunity—and that may have adverse effects decision about risk and reward. And if you can’t do on my program’s performance./ that, you probably shouldn’t be co-investing, be- cause you’re going to have a deal blow up—it’s just the law of numbers—and that’s going to be a zero on a line item in your portfolio. It’s no longer a zero inside a fund that no one ever sees. And if you can’t defend it and explain why you made the decision, what went wrong, and what was done to salvage the investment, you’re going to get shut down. People will stop investing with you.

Auerbach There’s program risk, process risk, and resource risk. If I don’t specify exactly what we all agreed

Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 14 PE PERFORMANCE AND PORTFOLIO / PERFORMANCE

Click to watch this video at privcap.com Maximizing IRR

Grabbing deals is often a priority for GPs, but many do not focus on optimizing the performance of the fund. Common missteps can cost funds precious points of IRR, experts tell Privcap.

low and steady IRR does not bring the manage the timing to raise IRR is the “European glamour of a smash-hit deal. So a lot of waterfall,” which directs more capital back to in- GPs focus on the latter and neglect the vestors earlier in the life of a fund and boosts net former, concentrating on blockbuster IRR. deals and forgetting they have a fund to manage. “IRR is so time-sensitive that steps you can take early in the life of the fund to affect cash flow both “I don’t think any fund manager intentionally tries in and out are incredibly important,” Kester says. not to optimize a fund,” says Kevin Kester, a man- aging director at Siguler Guff, speaking at a re- Consider the Dividend Recap cent Privcap roundtable. “But human nature, fund Many GPs get capital back to investors earlier via structure, and other pressures often create a situa- dividend recaps. But they’re not always the best op- tion where fund managers produce excellent deal- tion. by-deal returns but lose precious IRR points.” “Managers need to find the happy medium be- Sell When It’s Time to Sell tween when is the right time to do a dividend re- Another way managers shave points off their cap and when is the right time to sell the compa- net IRR is by not selling when the markets say sell. ny,” Elio says. “Too often folks lean toward ‘Let’s do a dividend recap, pull out as much as we can, and “There’s a lot of ‘I’m not done with my value-creation ride this as far as we can go.’ We saw what hap- plan’,” says Andrea Auerbach, a managing director pened in the last downturn.” at Cambridge Associates. “Managers don’t acknowledge the possibility that maybe they Often managers put a company into a process and should sell right now.” if the bids don’t hit their number, they do a lever- aged recap, return money to the LPs, and play on. It’s a hard decision to make. But Auerbach says it’s a This is popular now, given where interest rates are primary driver of top-quartile performance: selling and the availability of credit, but it raises questions. when it’s time to sell. “What’s the debt-to-EBITDA of that company?” Au- Pacing and calling capital when you need it—those erbach says. “Is it greater or less than what it was are two more imperatives for effective IRR man- before? Is it a covenant-light package? How bat- agement. “Another is deadwood,” says Michael tle-ready is this for what might be Elio, a partner at StepStone Group. “When you get coming down the road?” an opportunity to dispose of smaller, less successful companies in your portfolio, take it and move on. A Still, if managers know they’re going to sell a com- lot of GPs fall in love with deals and think that, giv- pany, then they should think about a dividend re- en a little more time and capital, they might rise to cap right away. “It’s a great way to move some IRR the occasion. That’s rare. Get rid of them as soon as points forward and lock in some returns,” Kes- possible.” ter said. “And if you don’t sell the company, well, you’ve already done the dividend recap. You haven’t Timing is crucial in making returns. One way to waited 12 months.”/

Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 15 PE PERFORMANCE AND PORTFOLIO / PERFORMANCE

Brazil Funds Gaining Strength Data on the performance of Brazilian private equity is thin, but Spectra-Insper says it has evidence of recent momentum By David Snow

Post-Crisis Surge: Brazilian PE Fund Performance The overall average gross IRR of the Brazilian funds tracked is 22 percent. Spectra-Insper says that per- Vintage Year Gross IRR (%) Number of Funds formance between 1990 and 1998 was weaker 1990Article Image 21.7 2 than US private equity funds during the same pe- riod. But the period between 1999 and 2008 saw a 1993Width: 4.7884 26.0in 2 Height: 4.38 in string of successful Brazilian PE fund performanc- 1994 15.7 2 es, albeit small in numbers, comparatively. 1996 7.8 6 In a recent white paper, Spectra-Insper chalked up 1997 9.8 4 this later, stronger performance to: “(1) the Bra- 1998 -6.7 5 zilian economic boom between 2004 and 2012 (2) still limited competition for deals in Brazil and (3) 1999 20.2 4 the fact that Brazilian PE and VC managers are be- 2000 23.3 4 coming more experienced, thus allowing for bet- 2001 60.3 4 ter performance.” One of the most vexing issues of investing in 2002 13.1 3 the emerging markets is the lack of performance 2003 47.7 1 data, allowing global investors to benchmark per- 2004 20.0 1 formance not only among managers within the country but against other markets. 2005 77.2 2 2006 60.0 1 But as is well known to investors in the most de- 2007 23.8 2 veloped markets, collecting performance data from GPs is difficult. Spectra-Insper says it has 2008 11.9 2 built a database using “data collected from PPMs and from interviews.”/

his is what the development of an asset class in an emerging market looks like – sparse and fragile at first, with strengthening numbers as the years go by.

Or at least that is the analysis of Spectra-Insper, a partnership between Brazil’s Strategy Center of In- sper and Spectra Investments, which has built a da- tabase of private equity funds across Latin America. For the Brazilian market, Spectra-Insper says it has information on 172 funds from 78 separate firms.

Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 16 PE PERFORMANCE AND PORTFOLIO / EXPERT PANEL Four LPs Talk Portfolio Privcap contributing editor Tom Franco recently talked with thought leaders from the LP community to learn their views on private equity in the portfolio, and the future of the asset class

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Vladimir Colas Ferdinand Seibert Frank Brenninkmeyer Scott Kalb Managing Director Managing Director Managing Director Executive Director Ardian Zurich Alternative Performance Equity Sovereign Investor Institute

Colas joined AXA Private Seibert has previous- Prior to joining Performance In addition to his role at SII, Equity in 2003 and previ- ly worked as investment Equity, Brenninkmeyer was Kalb is CEO of KLTI Advisors ously worked in BNP Par- principal at Swiss Life Pri- a vice president at GE As- and the vice chairman of ibas’ sell-side equity re- vate Equity Partners and set Management and also the World Economic Forum search department. has held positions in M&A held operational positions Global Agenda Coun- at CSFB and BNP Paribas. at a European retailing or- cil on Long-Term In- He received degrees from ganization. Brenninkmeyer vestment. Previously, Frankfurt University of Ap- received degrees from the he was CIO and deputy plied Sciences, University of University of Notre Dame chief executive of the Ko- St. Gallen, and EM Lyon. and the UCLA Anderson rean Investment Corpora- School of Management. tion. He holds degrees from Oberlin College and Har- vard University.

ARDIAN’S INDEPENDENCE DAY is the ownership of the management com- How Paris-based AXA Private Equity became pany. Out of the 320 employees, almost 300 Ardian; important trends in PE. With Vladimir of them participated in the spinouts. AXA Colas, Ardian hasn’t sold its private equity holdings— they’re still our number one clients. More Privcap than two-thirds of the capital that we man- How would you describe Ardian’s business age is third-party: pension funds, sovereign as it’s transformed from AXA private equity? wealth funds, insurance companies around What’s changed and what’s the same? the world. Nothing has changed with the investment process, the investment com- Colas mittees, the funds that we manage. We were founded in 1996 with $100 mil- lion under management. Now we’re close Privcap to $50 billion. Becoming independent was How would you describe the business? a natural evolution for us. What’s changed Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 17 PE PERFORMANCE AND PORTFOLIO / EXPERT PANEL

Colas estate, and infrastructure. A lot of that de- It’s a multi-strategy business within private mand is from LPs who have exposure to equity. We manage close to $50 billion, of those programs and want to increase it. which around $25 billion is a fund-to-fund We’ve seen more GP restructurings, but have program. Within that program we have pri- been cautious on that side of the secondary mary and secondary expertise—a mid-mar- market. kets buyer group active in continental Eu- rope and a growth-equity team. We have Privcap a co-investment program active in North Earlier you talked about Ardian’s roots in America, Europe, and Asia. Finally, we have a Europe’s middle market. Can you talk about direct infrastructure practice. what you see as the opportunities there in this post–Great Recession environment? Privcap How would you describe the value that Ard- Colas ian brings to GPs in the co-investment con- Historically, we’ve done well taking coun- text? try-specific companies. Our roots were in France, taking French companies and Colas making them European leaders. Now we It’s an important aspect of our investments. have an established practice in Germany When we make primary commitments with and Italy. On the direct side, the strategy a private equity manager, we hope to build a is taking smaller companies and helping broader relationship. We like to provide pri- them become European or world leaders. vate debt in some cases to make secondary It’s a good time for us to be putting capital acquisitions or help a manager open doors to work in Europe. for add-on acquisitions in industries or coun- tries where we have specific knowledge. On A GLOBAL INSURANCE GROUP’S the co-investment side, we have strong po- BET ON PE sitioning because we’re a direct group, but The role of PE in the insurance portfolio. With we’re also a fund-of-funds group. Ferdinand Seibert, Zurich Alternative

Privcap Privcap You mentioned secondary activity. What are From your perspective at a global insurance the underlying trends driving that market? company, what role does private equity or private capital play in the portfolio? Colas Through our fund-to-fund platform, we de- Seibert ploy roughly $2 billion a year on the second- As with most insurance companies, our port- ary side and about $1 billion on the primary folio is dominated by fixed-income instru- side. Both are strong legs to our platform. ments and publicly traded securities. Hedge Regulation is making it more expensive for funds, private equity, and private debt take a banks and financial institutions to hold pri- backseat to these fixed instruments. They’re vate equity. You have strategic shifts; some in favor because they’re expected to gener- pension funds deciding to go direct will ate alpha to compensate for their illiquidity. want to sell some fund portfolios. More gen- On the one hand, you have the publicly trad- erally, private equity is no longer an alterna- ed instruments offering liquidity, so it can tive asset class. It’s a several- trillion-dollar affect when the insurance company needs to industry and needs a robust secondary mar- rebalance its portfolio. On the other hand, ket. you have illiquid instruments that don’t al- low rebound financing, but they generate al- Privcap pha. It’s always good if we can demonstrate What innovations to the secondary market a clear difference between public equity and do you see coming down the pike? private equity.

Colas Privcap We’ve seen more secondary demand from Let’s talk about the fun part of the job: select- LPs for new assets classes like energy, real Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 18 PE PERFORMANCE AND PORTFOLIO / EXPERT PANEL ing managers. How do you assess a group’s need to implement value-creation strate- operating capabilities? gies. Do they have the ability to repeat this over time? Do they have the skills in-house Seibert to do that? Do they have the ability to create The words “operating executive” cover a va- and craft a portfolio? That’s what we’re look- riety of skill sets and levels of involvement ing for, and that will continue. in companies, and commitment and time to that endeavor. One has to go beyond the Privcap mere title of “.” Performance Equity is recognized as one of the more experienced fund-to-fund adviso- Many executives with operating capabilities ry organizations. The firm’s history is con- come with prestigious titles that may be nected to the General Motors Pension Group. helpful to start with, but one has to look be- How does that affect your thinking today? yond this to understand what they’ve done. What have they accomplished? What were Brenninkmeyer situations of adversity they had to overcome? Our heritage coming from the world’s larg- Do they have the credibility to speak with est corporate pension certainly influences CEOs of portfolio companies? Are they able us in a number of ways. The most important to share insights gained from working on is our mindset, which comes from manag- difficult situations with the management ing an asset class within a broader portfo- teams of portfolio companies? lio with the explicit goal of alpha generation and to assist the organization in achieving Privcap its return hurdles. I would contrast that with What do you see as primary benefits of a a more benchmark-driven type of approach co-investment program? where relative performance is a larger driv- er of portfolio construction and investment Seibert mindset. Our mindset really comes from the Co-investments have a lot of benefits. The GM heritage to be global in our reach and most measureable types are the financial opportunistic in our scope. We are agnostic ones in which it’s the mitigation of the to strategy, geography, stage. J-curve and performance improvement due to less fee drag. The less tangible aspects are Privcap the ability to better understand a GP and sat- In terms of evaluation of managers, do you isfaction of the private equity staff, who of- see a lot of research on the individual part- ten enjoy working on co- investments. ner? Is it the firm franchise that drives per- formance, or is it dumb luck? How do you BREAKING DOWN GP SELECTION sort those different factors? Tips for manager selection; strategy lessons from GM’s pension group. With Frank Brenninkmeyer Brenninkmeyer, Performance Equity Well, that’s a complicated question, and we’ve spent a lot of time thinking about Privcap that. It’s talent and luck. Luck plays a pret- We’re here to talk about GP manager selection ty important role in investing, but many and other important topics. Frank, things people are not that interested in admitting change, markets change; what worked in that, or even estimating what percentage of the past may not work in the future. How their return was attributable to luck. does that impact your deciding whether to WHAT THE SOVEREIGN commit to a manager? FUNDS WANT Brenninkmeyer The $6 trillion SWF sector wants more than re- I’d start by saying that the core levers of turns from its GPs. With Scott Kalb, Sovereign value creation are pretty well known. You Investor Institute have financial engineering, cost restructur- ing, top-line improvements, and expansion Privcap strategies. Those will remain relevant for a You’ve taken your experience as the chief in- period. Then there’s the skill that managers vestment officer of Korea’s sovereign wealth

Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 19 PE PERFORMANCE AND PORTFOLIO / EXPERT PANEL fund and repurposed it under a new ban- deploying 25 to 30 percent of their capital ner, the Sovereign Investor Institute. Tell us in alternatives, including private equity. So about that initiative. these guys are not content to simply be price takers or trend acceptors. Kalb The sovereign fund community is not very They have a mandate to try and develop their well understood by the financial commu- capability, or to help develop the capability of nity. They are underserved, and they are in their own domestic financial markets. And need of a forum where they can get together so they’re very active in trying new things and move their agenda forward. So I define and engaging differently. They’re moving the sovereign funds very broadly. It’s sover- aggressively to become more of price set- eign wealth funds, sovereign pension funds, ters and trendsetters. And that means that social security funds, central-bank reserve they’re approaching the GP community dif- funds—so all these very large government ferently. The days of simply saying, “I’ve got funds. Our goal is to create the largest pri- a great fund—do you want to put money vate-sector think tank for that community. into it, and I’ll make you return and give it What we want to do is give them a platform back to you?” are gone. There will always be a to get together and exchange ideas—it’s such place for good funds; I don’t think that goes a globally diverse community. We also want away. It’s just that it’s much more now about to be able to bring in outside experts, govern- partnership. Sovereign funds are looking for ments, academic leaders, and leading figures more than simply a fund product. from the asset-management community so that they can also learn and figure out what’s Privcap going on in the sovereign fund community. So it’s more than returns?

Privcap Kalb How much has the Returns are a requirement. If you don’t have sector grown in recent years? those, you can’t get in the game. So there’s a checklist. A sovereign fund is going to look Kalb at a firm that has a track record or individ- These large government pension funds are uals that have a track record. They have to investing in equity, they’re investing in real have good numbers; they have to have good estate, infrastructure, private equity, and institutional quality; they have to have good they’re insourcing. And even central- bank risk control; they have to have good servicing reserve funds are doing things differently capabilities; and they have to be transparent. now. So it’s very dynamic, and it’s a very new But then, once you’ve satisfied those boxes, phenomenon. If we go back to 2000, let’s what are the intangibles? The intangibles take the sovereign wealth funds, for exam- are: Is this a firm that’s going to help me in ple. There were only 14 of them. Today there accomplishing my mission overall? Are they are 75. There are new sovereign wealth funds going to be responsive? Will they come and being created practically every week. The sov- help do seminars for us? Will they help us ereign wealth fund community is of interest with education and training? Will they be because they’re so dynamic. They already flexible in how they work with us? manage about $6 trillion. They have an aver- age asset size of about $90 billion and average Privcap head count of about 200 people. Should GPs be worried if the sovereigns have a lower cost of capital? Privcap How should GPs approach the sovereign Kalb wealth opportunity? I don’t think so. What GPs need to do is think about changing the way that they interact Kalb with the institutional community. The old Before, we had maybe a handful of institu- models are going to go away, and you’ve got tions that were large and had internal ca- to think about how you’re going to work pabilities. Now there are over a hundred of with these guys./ them. And they’re growing by $400 billion to $500 billion a year in their assets, and they’re Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 20 PE PERFORMANCE AND PORTFOLIO / ARCHIVES

From the Archives Explore Privcap’s vault of recent videos forecasting 2014’s critical trends

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Privcap Special Report •PE Performance and Portfolio | Q2 2014 / 21 SPONSORED CONTENT

Click to watch this video at privcap.com

Expert Q&A with Steven Millner, Managing Principal, Gen II Fund Services

About Gen II Fund Services

Gen II Fund Services, LLC is an independent specialist provider of highly customized, client-centric accounting and administrative services to private equity industry spon- sors and investors worldwide.

How does Gen II partner with private equity firms for success? Gen II is a third-party private equity fund administrator, and we’ve been doing it longer than anyone. We work closely with private equity funds to support their back office. We’re the team that oversees reporting to investors, whether that is for/ financial statements, capital calls, or distributions. We keep the official accounting books and records for the firm. We maintain the investor data- base. We manage investor allocations and prepare waterfall calculations. We support the CFO or the person within the organization who has CFO-func- tional responsibility. We bring an expert platform to our clients—a platform of people, process, and technology.

Gen II is the sponsor of this briefing and the corresponding thought-leadership series. Please contact Gen II at [email protected] • www.gen2fund.com