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Institutional investor profile: Michael Granoff, Pomona Capital

Set up in 1994, Pomona Capital is mainly known for its secondaries investing, but the firm also manages a series of fund of funds. It is currently raising its fifth secondaries fund, with a target of $400m. Pomona has $1bn under management and has offices in New York and London.

What type of investments do you look for?
‘We source sellers of fund interests in Europe and the US. Our strategy is to buy the best funds that we can possibly find at a reasonable price. Many people think of secondaries as investing purely in distressed funds at a deep discount, and there are plenty of players on the market who do that. We don't look at distressed funds, but people often lump us together with the other players. Buying into a distressed fund is extremely risky and time-consuming and buying into them doesn't always represent value for your committed capital, no matter what the discount is. If it's a bad fund for whatever reason, it is likely to continue being a bad fund.

‘Instead, we look to get into the best funds. Limited partners have many reasons for selling. Often, the limited partner is seeking liquidity at an earlier stage that it had planned or it may find that, with the volatility of stock market prices, for example, it is over-allocated to private equity. Whatever the reason, you can gain access to some of the best funds through the purchase of secondary interests.'

‘On our fund of funds side, we are in a very good position to be able to invest in some of the top performing funds. We know how the best firms are doing through our secondaries investments because we spend a lot of time looking at the assets and not just listening to marketing presentations. We can gain access to them because we are already investors in previous funds through our secondaries business.'

How do you find out about good investments?
‘On the secondaries side, we spend a great deal of time proactively sourcing non-competitive deals. Because of our secondaries activity we can gain access to the best funds on the primary side as well. The two businesses have a lot of synergy.'

‘But we have been very careful about how we have structured the two different types of investment. Many other funds who do this tend to have one fund for secondaries and primaries. We believe that this creates a conflict of interest because there is a temptation to buy a secondary interest in a particular fund to ensure that you can be a primary investor in that firm's next fund or vice versa. Investors tolerate this, they don't like it. That's why we have separate funds for primaries and secondaries.'

How do you assess your investment opportunities?
‘You have to make sure that you understand the assets that you're buying - that's the key advantage of the secondaries business. You're not going in blind as you must with primary fund investments. So you have to really know what you're investing in. We look at each individual company in each fund.

‘We are extremely disciplined about price. Over the last couple of years we have invested relatively little - the prices were just too high for us. We're starting to invest more now that prices have come down. In retrospect, this was a very good strategy but it wasn't because we were omniscient, it was because we stuck to our principles on price. The numbers just didn't work for us. We're not asset gatherers, we are principal investors.'

What do you look for in a private equity manager?
‘Again, secondaries are different from primary investments because we don't have to take as make as much of a bet on the managers. Instead, we concentrate to a significant degree on the assets in a fund. We do still pay a lot of attention to the quality of the team - more so now than two years ago. Managers are working with us and for us, so we need to be sure that they are competent.

‘We look for a combination of things in a private equity manager. Their track record is clearly important, but we want to see evidence that they have been through the rough times as well as the good. They need to know how to manage through a downturn, they must know how to deal with it. They also need to have a defensible business plan. People are very good at giving advice, but they're often not good at taking it. This applies to venture capitalists as much as to anyone else - they look for investment opportunities with good business plans and help in implementing them, but they, too, need vigorous business plans and strategies. So they shouldn't just be following what other venture capitalists are doing. They also need to really understand the areas that they invest in. So we look for people with experience in the same industries as their portfolio companies as well as financial experience - they need to be an investor of choice for their companies because they can provide know-how and insight into the market.

‘We look to invest in firms that have a good organisational structure, with partners and staff that are incentivised in the right way. We wouldn't want the general partners to leave during the life of the fund, so we want to ensure that we're investing in a stable platform.'

With the difficult market conditions right now, it must be a good time to be a secondaries player...
‘It's a very good time at the moment in terms of deal flow but perhaps less so in terms of what is actually available to buy. I have never seen deal flow like this and it's to do with the market changes in recent years. We are now being approached by people asking us which parts of their portfolio we would like to buy - that used to be unheard-of. And it's likely to be a long-term trend. So much money has gone into private equity lately that we are seeing more deal flow as people present us with opportunities to buy four and five-year-old portfolios that they want to be out of. We have seen many people over-allocating to private equity and so this trend has been building for around four or five years.

‘However, it is a very risky time to be buying assets. If you're just taking a piece of the opportunity out there at the moment, you're certainly not guaranteed success. There are a lot of “opportunities” out there right now that just aren't worth picking up - no matter what the price. If you made the wrong choices in the past, you would have seen some poor returns, but now the punishment could be much more severe.

‘Having said that, time is now our friend, especially compared with the last couple of years. There is no need to rush in this market.'

What advice would you give to an investor new to private equity?
‘My advice would be to invest some of their allocation to secondaries for a number of reasons. Secondary exposure can be especially useful for people who are new to the asset class and to people who want to build up a private equity portfolio quickly. They can use it as a tool for building a mature portfolio pretty much instantly. Investors in secondaries don't have to wait the usual three or so years to start receiving capital distributions - they will get early distributions. For example, we have returned capital to our investors every quarter since inception. That's useful for cash flow reasons. It also helps justify investment in private equity to, say, the trustees of a pension fund who may be less happy to wait three or more years before they see any money coming in.

‘Secondaries also offer unique diversification. Typically we purchase interests in funds that are four to five years old. We can provide more than just more companies, we can provide a look back.'

What is the biggest mistake you've ever made?
‘We have bought secondary interests in around 70 funds so we have made our share of mistakes. They have generally been made when we haven't understood the underlying assets in an investment as well as we should have. That has happened when, for one reason or another, we have strayed out of the area of our knowledge and expertise. It means that we constantly have to maintain or even increase our focus and discipline. Everyone makes mistakes, but not everyone learns from them. Our challenge is to ensure that we do learn from them.'

What is the biggest issue for private equity?
‘In the main I'd say that the biggest issue for limited partners is that general partners are less healthy than they have been. But I'd like to split the issues into past, present and future.

‘Past. I think that private equity funds have a long way to go before they recognise what has happened in the past. They haven't come to grips with what has happened in their portfolio companies. Net asset values are not an accurate reflection of this.

‘Present. People are confused and are uncertain about what they should be doing because of the fog of war we're seeing right now. It is very difficult to see a clear picture of what is happening overall in the economy. The challenge for private equity fund managers is to see past this and spot the investments that will really do well for them in the future.

‘Future. Firms must continue to harvest their investments and build a solid structure for the future. To be successful, they must be able to manage their way successfully through the shock that we're currently experiencing. That will really lead to a shake-out. There will be an increased distinction between the A-class funds and the B-class funds. The A players will do well even in tough times. The B players will suffer some real pain. They will see some terrible performance and, as we're already seeing, many will lose money altogether. It makes it all the more important for investors to pick A-class investors.'

How do you think that the market will change in the future?
‘We already have a wide dispersion of returns between the best performers and the worst. That is only going to get wider. There are many people predicting that 50 per cent of the current GP groups will disappear. I'm not sure if the figure is correct, but we will certainly see some consolidation. Many people are worried about the deals that they did two years ago. The problem is that people tend to fight the last war - they are going to have to come to the realisation that the world has changed.

‘Despite all this, now is definitely a good time to invest. There is less competition than there has been recently, the prices are more reasonable and there is more time to assess investment opportunities. I think that people in the future will look back and say that many deals that were done in 2001 and 2002 were great deals.

‘Looking further forward, the best buy-out and venture capital teams will continue to outperform the S&P index, but not all teams will manage this. The opportunities and the risks will still be there in the future. Investors cannot bet on private equity as an asset class. They need to be invested with the best, and only with the best.'