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Investor profile: Ray Maxwell, managing director, INVESCO Asset Management

Maxwell on why fee structures are biased, on the argument against large buy-out funds and on the re-emergence of internet investments.

How do you put together a new portfolio?
‘It's a long process. We spend a lot of time looking at the various parts of the market. We try to determine which areas look attractive going forward, exploring quite a lot of the various markets, and then we will fundamentally see as many groups as we can and various subsections and then we analyse the cohorts. We evaluate six or seven groups, making a weighting, and out of that we then go into more detailed due diligence. It's an art rather than a science really.

‘We have a tendency to look much more at the venture area and small and medium-sized MBOs rather than the top end of the market. We believe that there are fewer deals available at the top and that the market has been conditioned by the auction process. We also think it's more likely that you'll be able to grow a £100m fund into a £500m one than it is a £1bn fund to £5bn. We're interested in cash multiples and so we tend to look more at the small to medium end of the market.

‘We also look at what's actually happening. In Central Europe, for example, we'd look at how much money has been raised, how much invested, and how much has come back. If we believe that the opportunities for realisation are limited then we will underweight that area. It's basically case by case. We'll look at certain groups that are pan-European if we think their strategy is sound but in other instances we will look purely at local players who have got a particular stream of good deal flow.'

How do you find out about good investments?
‘We have a name in the market place. We have our own website and because we've been around for 20 years a lot of deals, funds, investment opportunities just come our way. We tend to see more doing that than anything else. We do go out to trade shows and explore other routes but in the majority of cases it's that way.'

How do you assess them and what do you look for?
‘We look for something that meets our criteria. If it's a direct deal, that means generating a high rate of return to us over a three to five-year time frame. In the case of a fund, it's whether we believe it can deliver two to three times committed cash over the lifetime of the fund. It's a reasonably broad market but it gives us quite a lot of scope.'

What do you look for in a good private equity manager?
‘We look to see that the manager has identified a sound strategy in the market and assess whether he can articulate that strategy and deliver it. I think it's relatively limited (the sort of ability we are looking for) but overall I think the quality of management has actually improved in recent years. There are more people around these days who have been active in the market and they now know what we want and are capable of delivering it.'

What are the most interesting sectors going forward?
‘Clearly there's a greater degree of interest in life sciences. We have been doing it for a long time but we'll probably be doing a little bit more there on a selective basis. I believe that energy is going to be extremely important. And, remarkably, I think you are going to see a more sensible re-emergence of the internet. On a regional basis, we are fairly broad in where we are looking but fundamentally we think that those areas that are already established are the ones having growth going forward.'

How do you conduct your due diligence?
‘We look at groups in terms of them being businesses. We test the underlying assumptions such as, for example, how much is being raised relative to the size of the opportunity, how well resourced the organisation is to find and analyse and deliver good returns, where are those deals coming from. We also look at whether the business has a strong franchise in market, whether they are passive or proactive. We look at how good the analytics are, how much is carried out in-house and how much externally. We ask what the value added is, what the house brings to its investments. We talk to as many CEOs as we possibly can and ask what the house has actually done. We look at how good they are at identifying exit opportunities when making the investment and then whether they can actually sell the investment on.

‘A lot of people talk about private equity portfolios. We don't actually do that. But what we do try to do is to understand the dynamics of the portfolio. Where is it relative to the original business plan, relative to the budget? Has the exit changed, the time horizon changed, or the outlook changed? We try to get a real view of whether money can be made on a portfolio. We are looking at the EBIT and all the rest of it but we don't break it down to the last penny. We get a combination of that and all the other basic metrics. How are the investments going to be sold, and the carried interest distributed? It all gives a good impression of what is going on.

‘We like to stretch it out as long as we can, between three and six months. Very rarely, unless it's a group we've invested in previously, are we ever going to be in the first closing. And we are taking more and more time. We have to really examine the competence of people to manage business in a deflationary environment.'

What advice would you give to a new private equity investor?
‘Use a fund of funds. There is a lot of product out there, there is very little transparency, and people tend to accentuate the good and underplay the bad. New investors need to buy into experience. Certainly a lot of people out there are saying they can offer that, but I'm not sure if there are many that really can.

‘In the UK, because of the Myners report, people are coming kicking and screaming to private equity with very little enthusiasm. Often, because of deficiencies in pension funds, they don't want to lock money away for a long time and with no guarantee of success. But there are other concerns.

‘One of the things that would be a concern is that private equity valuations have fallen in line with equity valuations so why on earth would you need to be in private equity? One of the explanations has often been that there is a low correlation between the two but clearly the correlations are very strong. They have always been close.

‘The assumption then is about what you believe the returns will be relative to the equity market and I think the jury is still out on that one. If you look at your costs in investing in equities relative to private equity, you are paying so much more in private equity than you should be. The management fees are high. Performance or profit share is high for a very marginal return over the market. These are issues that are not being properly considered.'

What's the biggest mistake you've ever made?
‘The biggest mistake I made was in my (pre-Invesco) days of investing directly in deals. It was investing in Mark One and it was an unmitigated disaster. It basically led to a wipe-out of our investment. I had my doubts and I think the lesson was that you should always stick to your judgment.'

How do you think the market will change in the future?
‘At this point it's very difficult to know. I don't think we will be seeing the massive returns again. I don't think we are going to go back to the nineties and the ten-times-our-money mentality. That is well and truly over for a long time. I think the business is going to become much more professional, companies are going to be more fully funded, and more thought will be put into how businesses are developed. If they are coming to an IPO, it should be used as a fund-raising activity for the business rather than a way of exiting all the investors out.

‘I think the fee structures will change - they are too rich for general partners. There is certainly a shift of power now back towards the limited partners. GPs are finding it much more difficult to raise money and I think sooner or later someone will come up with a more innovative structure that will then become the benchmark.

‘A number people have come up with structures but they haven't stuck because there isn't really any coordinated thrust by buyers of the product. A lot of the limited partners are fund-of-funds and clearly they don't want to upset their relationships with the GPs. Equally they don't want to be led by other fund managers who may be seeking better terms and conditions so there is an inbuilt inertia there.'

Do you expect much of a shake-out in the market?
‘We've seen a period like this before and the shake-out was very, very limited. The reason being was that those who had raised money could work their way through the cycle. But this time there are a number of funds, particularly the internet ones, that raised a lot of money very quickly and invested it very quickly but they are now pretty much high and dry. They were new arrivals and they will disappear. But the more established players, the slightly more cautious ones, I think will continue to do well.

‘The issue also is what is going to happen in the investment banks. I think there will be more of a shakedown there because a lot of profits were coming from private equity and of course those profits have now disappeared. There will certainly be a change of emphasis.'

What is the biggest issue facing the private equity industry?
‘The biggest issue is convincing the market place that it is a genuine asset class. It's about standardising terms and conditions and standardising performance so there can be a broader assessment of the capabilities of one group against another.'

Chris Davison is head of research

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