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Institutional investor profile: Ashton Newhall, Principal and Co-founder, Montagu Newhall

Newhall on the promise of early-stage opportunities, on the difference between US and European venture capital markets, on the persistence or otherwise of brand names and on the lack of experience of many VC fund managers.

Based in Maryland, US, and London, Montagu Newhall was established in December 2000. The fund of funds raised its first fund in 2001 and is expecting to announce a closing of its second in July with commitments from US and European investors. The firm currently has $52m under management. Montagu Newhall focuses on venture capital fund investments, mainly in the US, but also has a co-investment programme. Newhall co-founded the firm with Rupert Montagu and was previously at T Rowe Price Associates.

Why did you decide to set up Montagu Newhall?
‘We felt that there was a gaping hole in the market. We wanted to set up and fund of funds as a one-stop-shop vehicle to allow small to medium-sized institutions and high net worth individuals, particularly private equity professionals, access to the pre-eminent firms within this asset class. We felt that, given our history and our relationships, we had a unique ability to provide clients access to funds that are significantlY over-subscribed and to identify up and coming managers and co-investment opportunities. Both our co-founder Rupert Montagu and I have a history of private equity in our families. My grandfather used to work with the Rockefeller family and helped found Venrock Associates and my father started New Enterprise Associates. And Rupert Montagu is a second-generation venture capitalist in that his father founded Abingworth Management.'

How is your portfolio constructed?
‘Montagu Newhall is an international venture capital fund of funds. 80 per cent of the assets go to venture capital partnerships and 20 per cent directly to companies. Within the fund investments, we take a two-pronged approach. 80 to 85 per cent of the fund investments goes to established venture capital managers and the remaining 15 to 20 per cent goes to what we loosely define as up and coming venture managers. Within the direct strategy, which is made up largely of co-investments alongside the venture managers that we have relationships with, we look for later stage opportunities. Geographically, we invest 90 per cent in the US and ten per cent internationally, the majority of which is made up of Western European investments.

‘We focus on early-stage venture capital firms that follow their investments through their life cycle. As a result, we tend to invest in funds of $100m or more - these are the ones able to keep dry powder to support their portfolio companies throughout their development. We would add one or two later stage managers where we felt it was appropriate to help balance out the portfolio. But generally speaking, we are a manager of managers that backs early-stage venture capital firms.'

Why do you focus so heavily on early-stage managers?
‘We focus so heavily on this part of the market because, if you look at the figures, the returns on early-stage investments have historically outperformed other areas of the market. There are a lot of reasons for that, such as the fact that the managers are able to get increased ownership and lower valuations by coming in at the seed stage of the business. We felt that the return profile made the most sense. Our clients were also looking for a way of accessing these opportunities across a diversified portfolio.'

How do you source your “up and coming manager” opportunities?
‘When we look at up and coming managers, we're looking for general partners at established firms that have decided to open up their own shop or for funds that are raising institutional capital for the first time. The ones we tend to back have Roman numeral III or IV after their names rather than being pure first-time funds. They will have a demonstrated and verifiable track record of outperformance of their peers in a given vintage year. I think that you find those opportunities in a variety of different ways. We have a very active and engaged advisory board and investment committee, the members of which still do deals and can therefore report back from the front line. We are active ourselves and there are managers coming to our offices all the time. In addition, we tend to pick the major hubs of venture capital activity, whether that's the Southeast, the Boston area or Silicon Valley, or whatever, and we will look at all the firms based there to decide which are the firms that we really want to be invested with. So it's a mixture of top down and bottom up approaches.'

Which sectors do you tend to target?
‘We target three main areas. Broadly, these are: IT, communications and healthcare and life sciences. I think that is something that really differentiates us from some of our peers - we have over a third of our assets in healthcare and life sciences, going back to 2001 and 2002. I think that was viewed as a high percentage then by the market, but today many people probably wish they had a higher percentage allocated to healthcare and life sciences.'

What's your view on each of these sectors?
‘I'd like to start off by making the point that this asset class is not one that you can dabble in. It's very difficult to try and time venture capital. Our family has been investing in venture capital for three generations, but I don't think that any one of us could have told which were going to be the best vintage years at the time. It's critical that if you invest in this asset class that you maintain vintage year diversification.

‘On the specific sectors, I would say that the fundamental promise of next generation information technology, communications and healthcare and life sciences is as profound as it ever was. It's just that the opportunities to monetise company creations via IPOs or acquisitions are not as frequent events as they once were. For investors, it depends on their time horizon, on their risk tolerance and what else they are doing in their overall portfolio as to whether they should be invested in these areas of venture capital. But our view is that there should be a place for a venture capital allocation for most sophisticated investors.

‘The big issue that we have seen has been the fall in capital expenditure among companies for technology-based products and services. It has been very challenging to sell into these markets. As a result, on the direct side, we have been very active in the healthcare and life sciences arena. When people have a medical need, they will pay for whatever product or service they require. But having said that, we are starting to see a rebound in IT capex. It will be an easier environment going forward than it has been over the last couple of years for companies trying to sell IT-related products and services.'

What's your perspective on the difference between the US and European VC markets?
‘Given our weighting to the US, we still view it as one of the pre-eminent VC markets to be investing in. The eco-system is much more developed than it is in Europe. That doesn't mean that there won't be promising opportunities in Europe, but the managers' experience isn't generally as great as it is in the US and the liquidity options diminished significantly with the demise of secondary markets such as the Neuer Markt and the abandonment of the Nasdaq Europe efforts. As a result, we like to back managers in Europe that have one eye on the US and one on Europe. If they build a technology-based company, that means they can ultimately sell to the US and potentially be acquired by a US company.

‘I would say, though, that the European market has changed a lot over recent years. The main change has been in psychology. It used to be that if you tried to start a company and if you weren't successful, that was it. I think that has evolved over recent years. It's not the same as in the US, but it is now more acceptable in Europe to take risks - if you fail, you pick yourself back up and you try again. I also think that you are starting to see the emergence of serial entrepreneurs. That was something you didn't see in Europe until relatively recently and it helps build the eco-system necessary for a thriving venture capital market. For example, you're starting to see service providers that understand the needs of start-up companies.'

What do you look for in a fund manager?
‘We look for significant outperformance versus their peers in a given vintage year. With the established firms, I would say that the largest issue they are facing is succession and so we look very closely at that. We want to be sure that they have brought in a next generation of managers that is at least as competent as the original team. We want to see that the carried interest is shared throughout the team. We look at the team dynamics - how do they relate to each other? That is something that you really have to go out and see, touch, taste to get a feel for how cohesive a group really is. We also look at whether the firm has employed a relatively consistent investment strategy.

‘Generally speaking, we also like to see a combination of operational and managerial experience. That hybrid is very helpful for evaluating opportunities and seeing whether a potential investment has legs.

‘Beyond that, each fund has a different bent to them. The only way you can be sure that you're backing the right people is to kick the tyres.'

In which areas do you feel that many funds are lacking?
‘In the late 1990s in Europe and the US, there was a proliferation of managers - some with experience and some without. I'm not saying that some of the newer funds will not be successful. But in our view, it is very difficult to determine which of those firms will be tomorrow's blue chip managers. They just do not have track records.

‘As a manager of managers, you have two things going on right now. You have established managers whose first generation is going to be retiring soon. You need to be certain that the next generation is going to be up to scratch. And you have the up and coming funds that raised and invested during the peak and that are now scrambling at the trough to find realisations. These managers are not necessarily bad managers, but it's just that it is difficult to tell. That's our challenge going forward.'

What is the biggest mistake that you have ever made?
‘I think that we were a little over-optimistic about the opportunities available in Europe. It has proved to be much harder to find high quality venture capital firms there than we had anticipated and as a result, we have had to lower our allocation outside the US.

‘It's very important not to invest in partnerships based on hype - just because a fund is oversubscribed, it doesn't mean that the manager is the best for your portfolio. The institutional community that invests in this asset class can be accused of a herd mentality at times.'

What irritates you about private equity?
‘The fees that some firms charge are egregious. If you started out in the 1970s, were running a $16.5m fund and charging a 2.5 per cent management fee, that made a lot of sense. But if you are a multi-billion dollar fund and you are charging 2.5 per cent, I'm not sure how much sense that makes. Our view is that we don't mind paying higher carried interest if management fees come down. Most institutional investors object to paying higher carried interest, but we would be happy to pay 35 per cent carry if the management fee was lowered to 50 basis points. If you do the math, you can support that argument. We have done analysis of management fees and carried interest and the conclusion is that management fees are extremely detrimental to long-term performance.

‘We would also like to see a return to the way partnerships were structured in the past. Fund managers should not see carried interest until they have returned drawn capital and the management fee to their investors.'

How much room for negotiation do you have on these points?
‘Every institutional investor takes a different approach to negotiating. We take our fiduciary responsibilities very seriously, but we don't think it's our duty to nickel and dime general partners on every sub-clause of the limited partnership agreement. With the established firms, we find that the terms we are looking for are largely there already. But we often find that the up and coming firms are the ones that we have to negotiate with and spend time redrafting the agreement. This is mostly because they are not used to having standard terms in place - they will generally have started out raising money from high net worth individuals.

‘But I would have to say that we have very little, if any, room for negotiation on those top notch funds that are over-subscribed. There, I think that we would have to make an investment decision based on the merit of the fund. Someone once said to me: “You can't let the tails term wag the investment dog.” We see investments in the same way - as long as terms are basically within reason, they should not be deal-killers.'

What is the biggest issue in the market?
‘There has been a real push to institutionalise the asset class. But I have questions about whether this is an asset class that can be institutionalised. You are backing entrepreneurs at a very early stage, they need hands-on support and help from a venture capitalist. It remains to be seen whether franchises can institutionalise themselves in perpetuity.

‘The other issue that runs hand in hand with this is that of brand names in the industry. There is no doubt that being a brand name can help a fund raise money from institutions and attract some of the brightest entrepreneurs. But if we were to sit here in 20 years from now, I wonder whether today's brand names would still be around. With a public fund management company, I think that the answer would be yes; with a private equity fund manager, I am less certain.'

How do you think that the market will change in the future?
‘To a certain extent, I feel as though we are back to the future. The industry is, in many respects, back where it was. Due diligence periods have already lengthened, I think we'll see a return to general partners having between five and eight board seats per partner. A lot of the general partners are now putting much more effort into the portfolio companies than they were in the late 1990s. We are also seeing the number of managers out there decrease and the quality of the deals has increased. The tourists have gone home. All these things are positive for the industry as a whole.

‘Fundamentally, our business is about backing funds that start companies that change the world. We as investors are the financial engine behind that process. Sometimes people lose sight of that.'

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