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Institutional investor profile: Reinhard Hartl, Director, Global Vision Private Equity Partners

Hartl on the fading attractions of the large buy-out market, on the cyclicality of private equity, on the need for dynamic incentive structures, on the prospects for Germany and on the lack of patience among fund managers and investors.

Global Vision Private Equity Partners is an independent private equity fund of funds investment manager and advisor for retail and institutional clients in Germany, Austria and Switzerland. Based in Frankfurt and Hamburg the firm was set up in 1999 and now has E250m under management across five funds of funds. Global Vision focuses on investing in venture capital and buy-out funds in Europe and the US, but it also has an interest in secondary transactions, special situations and mezzanine. Reinhard Hartl joined Global Vision in 2000 to take charge of fund investments. His previous experience includes managing the assets of two family offices with a particular specialisation in private equity and practicing as an independent consultant for small, growing businesses.

What type of investments do you look for?
‘We have focused on the main areas of private equity - buy-outs and venture capital funds. We do make investments in secondary positions, but we think of them as part of buy-outs and venture capital rather than a separate category and tend to approach them by comparing interesting secondaries transactions with our existing portfolio of fund investments. There are a lot of opportunities in the market at the moment, but we look at them very carefully. We prefer those that are a few years old and close to being fully funded. To a smaller extent we also make investments in special situation funds, including mezzanine.

‘From a geographic point of view, we are of the opinion that as a Europe-based fund of funds with a deep knowledge of the European market and with a base of European investors, our value added to investors lies more in Europe. As a result, you will find a stronger allocation to Europe in our portfolios compared to other competitors. We also prefer to keep the US currency risk low.'

How does your allocation process work?
‘We first use a top-down approach to private equity investment and it's from that starting point that we then analyse the markets from the bottom up using our own database and network. We have built what we call a “private equity clock”. This instrument is the result of our ongoing macro and micro-analysis of the private equity markets and indicates when, where and in which market sectors we ought to be investing.

‘Bottom-up, we maintain a “top 100 funds” list with funds we would like to invest in when they are out fundraising. We use a proprietary ranking system to compile this list.

‘At the moment the clock shows that now it is the best time to be investing in US venture and both US and UK buy-outs. Further along continental buy-outs and venture capital will become attractive. Consequently we have invested over the last few months in several US and UK-based funds. Shortly we will turn our investment focus more to the other areas.'

Why did you decide to formulate this clock?
‘Our analysis showed us that private equity is a cyclical industry. To really understand what is happening in the market, you have to go into a huge amount of detail - and that is what we have done over the last few years. We have looked at the macro and micro correlations and we have analysed the results from the industry - we discovered that there was a pattern to it. We wanted to formulate that analysis and the conclusions we drew from it into an instrument that we could update on a half-yearly basis. We are able to provide our investors with it and it helps them understand what we are doing and where we are investing their money. We can also show it to people in our network and to placement agents so that it is clear to them the areas we are interested in at any point in time. In a way this contributes to the transparency of our activities.'

What do you look for in a fund manager?
‘We use a ratings system to analyse potential funds. We have separated certain attributes that we would expect to see into a few main categories. These include the team, strategy, experience, track record and terms and conditions.

‘We look for outstanding teams with the right experience for their strategy and a clear task assignment, ideally led by a strong group of dedicated principals. We particularly look for teams with operational as well as financial skills. This is very important in today's environment. There has been a change in the way that private equity managers are able to create value - they can no longer simply rely on financial engineering to produce returns. They need people on board who can work with companies to improve them. These operational people must be an integral part of the team and have to be fast and flexible in employing their resources quickly. Some teams use their networks to provide operational expertise, but we don't buy into that concept. Where is the incentive for an outsider to do the best job if they are not part of the team that is receiving carry?

‘We also look at the incentive structures in a fund. We want to be sure that carried interest is shared fairly between team members rather than simply being distributed to the top personalities in a group.'

How much of a problem do you think share of carried interest is?
‘Carry is a quite widespread problem. But one problem we are seeing right now is that those funds invested during the hype are not going reach their hurdle rates - and I'm talking here about buy-outs as well as venture capital. The question is: how do you incentivise the best people in the team if there is no prospect of carried interest? I think that we will see a lot of good people leaving teams as a result. Current incentive structures don't really deal with this kind of problem.'

What kind of solution would you like to see?
‘We would like to see more dynamic incentive structures put in place. But we also think that limited partners must be understanding. They should try and agree new incentives with managers. Of course the terms should be fixed at the beginning, but there must be some way of taking account of changing market conditions. It has to be in everyone's interest to ensure that the good people stay on board.'

What is the biggest mistake you have ever made?
‘We probably over-estimated the development of the German market. We expected the overall infrastructure for private equity to develop much faster.'

How do you view the future of the German market?
‘We are positive about the future, though. We believe that the development has to happen at some point in the future and that the German-speaking area of Europe will become a major force in private equity. We will see a lot of movement in the next two or three years in both buy-outs and venture capital. There are some real political changes going on in terms of taxation and banking system. We have some very strong entrepreneurs in Germany - they simply need to be convinced by professional managers that it is better to choose private equity for their financing than to rely on the banks. This is probably one of the most important tasks of a private equity manager in Germany. And as a result, we believe that established local teams will have the advantage over some of the foreign players that have set up offices here. It's a question of mentality. Germany is very unlike the UK, for example, in that people tend to stay within the same companies for the duration of their careers. As a result, business owners believe they have a social responsibility to their employees. This is changing and the labour force is becoming a little more flexible - and the more that happens, the more opportunities there will be for investment.

‘There are also structural changes that will boost the market. Basel II, for example, will mean that banks will concentrate on banking activities rather than diversifying into other areas and will provide an impetus for captive teams to spin out and set up independent firms. It has already happened in the UK and it will happen soon enough in Germany. And that could help create more activity in the market.'

What irritates you about private equity?
‘I get irritated by the exorbitant short-term expectations of all market participants. Too many people also ignore the risk/return profile of the asset class. I find that the managers in some of the more established asset classes are actually more patient than those in private equity. Too many chase opportunities believing they are the next big thing when they should be keeping in mind the fact that private equity is typically a long-term business.

‘But I also think that investors need to have more patience. Private equity has a huge advantage over publicly listed stocks in that managers can work to improve a company without having to worry about quarterly figures and what their shareholders will think. Top management in public companies have to act in the way the market expects at any point in time and that can lead to short-term measures being taken. Managers in private equity-backed businesses can focus more on essential company activities, working for longer term gain instead of addressing short-term demands of stockholders.'

What is the biggest issue in the market?
‘The biggest in the market is the predicted poor returns on 1998 to 2000 vintages. This will have a huge impact on managers' motivation to bring these funds to a reasonable end while being aware that there is nothing to win. People aren't really talking about it because it means that they will have to admit that their own fund performance will be poor. This could be positive in some respects because you are likely to see more spin-outs led by some of the best managers. But they will not abound as many of them are being put off by the poor fundraising conditions.'

What's your view on the future of the fundraising market?
‘Our view is that things will not pick up for a little while. Some investors are starting to come back to private equity, but there are plenty of others that are still in a state of shock about the losses from their public market portfolios. This will change and we are quite positive about the medium term as investors start looking for alternatives to public stocks. The drop in fundraising we have seen over the last couple of years is nothing unusual. You have to understand that we are in a cyclical business: some years are good, others aren't. Fundraising has always chased returns and the returns are nothing to boast of at the moment.

‘We see our biggest task as informing investors about the market. We aim to be open and communicative with investors in our funds. We don't believe that we have done everything 100 per cent right and so we will be honest with them. The key is that we have learned from our mistakes. We also know that some of the things that have happened over recent years will not be repeated.

‘Our message is that you always have to be a bear and to keep in mind the risk/return ratio. You should never expect 50 per cent plus returns year on year. Investors and players in the market should be aware that private equity has become established and should be a part of a well balanced portfolio - there are many more private companies around than there are public ones. This alone should be one reason for a serious investor not to ignore this asset class.'

How do you think that the market will change?
‘We are already seeing too much enthusiasm in the market for buy-outs. Nevertheless we believe that there will always be lucrative segments within the buy-outs area, each with different characteristics and levels of competition. If you look at large buy-outs, there are some interesting opportunities emanating from the large blue chip companies divesting their non-core assets. Funds are paying very high multiples for these opportunities. In fact, people have been saying for years that large buy-out funds are paying too much and yet their returns are consistently good. Perhaps not in the 50 per cent bracket, but at least between 15 and 20 per cent. Having said that, we nevertheless feel that the attraction of large buy-outs is beginning to fade. There are perhaps too many players in this area, many of them with their largest ever funds. It has become a very competitive space. On the other hand, this does not automatically mean that the mid and small market are the best places to be. You have to look very carefully at what the abilities of a management team are and where they have created proven and consistent returns.

‘For us it makes no sense to allocate more than a small portion to mezzanine because we believe that there are very strong stories in the more classic sectors of private equity - buy-outs and venture capital. It makes much more sense to go into mezzanine, distressed and special situation-type environments when you are not so confident about classic private equity. We have reached the bottom in many markets, and when you reach that point you are too late to go into other areas.

‘Over the next few years we will see the best opportunities coming up for venture capital. Continued low pricing due to the market consolidation and a more conducive economic environment will favour the development of successful young companies again.

‘In the end the survivors and the best performers will be those with a good mix of skills on the team. You need to have people on board who have created businesses before and who understand the challenges. We believe that the firms populated purely by ex-investment bankers will struggle in today's and tomorrow's markets.'

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