Click here for printer friendly page

Institutional investor profile: Graham Sturrock, head of investments and mezzanine

Bank of Scotland is a relative newcomer to private equity fund investing, although it has made direct investments for a number of years. It set up a fund of funds to invest from its own balance sheet three years ago.

What type of investments do you look for?

‘We invest in standard limited partnerships and we also do cornerstone investments but we prefer to do them with at least one other investor. It gets lonely on your own!

‘We invest both for relationship and return.  Our investment strategy is an integrated element of the Banks leveraged debt activity.

‘Our current positioning is that we are in 83 funds with £800 million committed. Within that there is a big range of size and investment. Some go back to the very early days so our average investment size has come up over the period.

‘Our focus is obviously in buy-out funds and the majority of our investments are in mid-market UK and pan-European funds. If you look at our underlying investee companies they are split 50-50 between the UK and continental Europe. We would expect that to shift 60-40 Europe to UK over the next few years. We do also invest in some first time funds. In our portfolio there are six first time funds - two buy-out, two technology and two special situation.'

How do you find out about good investments?

‘On buy-out funds our starting point is their involvement with the bank's leveraged finance activity. It is important for us to have a relationship with the private equity house, both in terms of their accessing our leverage to their investees and in terms of understanding the house track record. It's a bit chicken and egg -we've been providing leveraged debt to the mid-market for ten years and only been in private equity for about three years.

‘Then some come through general contact, particularly through investors in other funds, and there are also a small but growing number of consultants.'

How do you assess an investment or a private equity team?

‘The key item is the investment strategy of the house as most other things flow from that. It is vital to have an understanding about where the investment opportunities lie, deal source, and the value creation process.

‘The next thing down the list would be the track record and delivering on that strategy. Where there is no track record, we look at either the personal experience of the individuals or other complimentary activities.

‘On people, it's a case of looking at the individual mix and the level of experience of the team. We look at whether they have the structure to fit the strategy. We also look at their business advisory boards and any industry specialist groupings that they utilise particularly where this is a main plank in the strategy.

‘Within the team we look for people who have some individual flair as well as a good team balance. A good investment manager will have focus, perhaps be a little eccentric, and will have an optimistic streak and be highly wealth-driven.

‘In a first time fund, there has to be a substitute for the track record somewhere. We look for a decent governance record. And there has to be something there for you to offset the additional risk.'

How do you put together a new portfolio?

‘We want to get a spread of small and medium and large houses within our portfolio so that we cover the ups and downs of the different sectors in the market. We don't look at limited sectors.'

What are the most interesting countries or sectors going forward?

‘I would say traditional buy-out houses. Our areas of expansion are geographically further into Europe. In terms of investment stage, some selected early stage houses and in terms of products, more mezzanine and special situation

‘One of the big questions is when is the dam going to burst in Germany. The tax and regulatory environment is changing, which will probably have an effect next year. There is plenty of pent up private equity capability there. That's something to watch.  Spain is an emerging market and there are a number of houses establishing themselves there, again because of a change in the regulatory and tax environment. There is also growth in specialist areas like property, private finance initiative, food and consumer products.'

How do you conduct your due diligence?

‘We have a big advantage because almost all our due diligence is done in-house. We should be investing with people we know and do business with already and that means we have great insight into a house and its track record. More particularly, the guys on our debt side will have dealt with them so they have excellent personal references. We do occasionally use consultants, particularly on continental funds.'

What advice would you give to someone looking to invest in private equity for the first time?

‘Be interested in your investments (i.e. the team) because that is where the fun is! It is a team you are backing. The team should have the enthusiasm and that has got to rub off, even some of the stodgier investors. It is all about strategy and team for me.

‘Your portfolio has to avoid concentration of risk.  It is a trade off between spending the time to build it yourself or achieving spread more quickly by following others who are already doing it or using a fund of funds.'

What do you think will be the key market dynamics in the future?

‘It is definitely going to become more professional as it becomes a more significant driver of activity in the economy.

‘The biggest issue at the moment is uncertainty. Everyone you speak to would say it is a great time to invest but visibility of earnings must be a concern. And if asset prices are falling for acquisitions then they are also falling for exits. Certainly if you are a bigger fund then there is more uncertainty because of the enormity of the transaction sizes.

‘Over the next two to five years it is also going to become harder to get exceptional results and one of the biggest issues is going to be maintaining the return levels. Value creation and timing the engineering of exits will be crucial. There are a lot of institutions that want to come in to the asset class. Houses will need to work to keep the returns up.'

Chris Davison is head of research at Almeida Capital

Comments? E-mail editorial@altassets.net