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Institutional investor profile: John Barber, Managing Partner, Citigroup Private Equity

Barber on the need for diversification in a fund of funds portfolio, on the negative impact of mark to market in the private equity industry, on the danger of an imbalanced management team and on the importance of a consistent strategy to add value.

Citigroup Private Equity has been investing in private equity for more than 20 years, through Citigroup Private equity and its predecessors. The entity invests both directly and through fund of funds. It currently manages in the region of $3.5bn of capital in a broad spectrum of fund of funds products with an extensive geographical and sector focus. As managing partner of Citigroup Private Equity, Barber oversees all direct and fund investments in North America and Europe. Prior to joining Salomon Smith Barney in 1995, Barber worked for Kidder, Peabody & Co where he was a managing director and a member of the firm's commitment committee.

What type of investments do you look for?
‘Citigroup Private Equity is responsible for the group's private equity fund investing, its direct co-investing, and all of its mezzanine investing.  We invest in private equity on behalf of third party clients and also with proprietary capital.

‘Citigroup has managed a large number of fund of funds products over the years. Some have been fully diversified and some have been single feeder. Some of those funds are buy-out focused and some venture focused. We also sometimes have funds of funds focused on a particular sector, communications for example. But in general I think you could say that we have a globally diversified fund of funds offering.

‘We really believe in diversification. We like to diversify by geography, by investment stage and by company size. We also diversify by industry focus and by the maturity of the fund group. We believe that our fund of funds capital should be invested on a globally diversified basis. We invest in Europe and in the US, in small, medium and large cap buy-out funds, in venture funds and in funds that invest in distressed situations.

‘So, in general we have a very broad scope when it comes to our fund investments. But in terms of our current preferences, you could probably say that we are under weighting venture and that we feel positively about Europe.'

Why specifically are you steering away from venture?
‘I think that the supply/demand equation within the venture market at this time does not make for a good risk/reward return programme.'

How do you go about putting together a fund of funds portfolio?
‘We have a basic allocation model for our fund of funds business.  That model covers how much we are going to invest in each area of our portfolio. It governs how much we will invest in US large cap buy-outs for example, and how much we will invest in the middle and smaller end of the market. It governs how much we're going to invest in Europe, how much in venture, and how much in distressed situations.  We have ranges, in terms of the amount to be invested, within each of these categories, and a thought process as to the number of funds that should be invested in, in each area.'

How does your investment process itself actually work?
‘We have a very thorough and active due diligence process.  First of all, we have been, and still are, a major investor in funds. We are currently an investor in over 250 funds. This means that a lot of our investment process involves being on top of funds we've already invested in and deciding whether we want to re-up.

‘But for all funds, including those that we have invested in and those that we have not yet invested in, we maintain a proactive and comprehensive due diligence process. We spend a great deal of time reviewing the activities of the firms. We aim to learn as much as we can about the past and expected results of a firm's portfolios. 

‘We spend a tremendous amount of time and put a lot of focus on the organisation that we are investing in. How we see that organisation today, and just as importantly how we see that organisation over the next five to ten years. Ultimately that is the length of time that the firm is going to have control over us and over our money.'

How long does the investment process generally take?
‘It is very variable. For example there is a fund group that we are looking at the moment that we have been investing with for 20 years. Obviously it takes less time if a firm is raising its eighth fund and if we've been working with them for all of that time. But I would say the range is generally between two and 12 months.

‘But I'd add that we don't think that the best way to look at fund is to do due diligence and to analyse the fund within a static amount of time. We make sure that we are constantly monitoring the funds that we invest in, staying in touch with them, and making sure we understand their portfolios and their people on an ongoing basis.

‘Equally, if there is a team that we know is out there and that we think are an interesting group but that we haven't invested with before, then we will meet with them two or three years before they come to market. That means we get to know them over a longer period of time. The advantage is that you are not looking so much at a snap shot of the fund and the team, but more of a movie picture.'
 
What do you look for in a private equity manager?
‘One of the things that we've learned in private equity investing is that there is no one right way to do it. We don't have a fixed right answer. It is not a case of, if you are in our box you're good, and if you are not you're bad. We really try and look with an open mind at each private equity firm, what they do well, why they do it well, and whether they will continue to do it well. If we understand that, and are convinced that they have the foundations to perform well with consistency and longevity, then we will invest with them.

‘What we do look for are some key characteristics. Apart from the importance of a team's track record, we also want to we see a stable organisation. By that I mean that we want to see an organisation that has grown and developed, and that has people of multi-levels. We also want to make sure that there are enough people to invest the amount of capital in the fund and that the carry is fairly distributed.

‘In addition we want to see an organisation that we think adds value to its portfolio companies once it owns them. A firm must have a consistent and convincing plan as to how it will go about adding this value. For example, some people won't do a deal unless they have a CEO that they are going to bring into the situation. Sometimes a firm will choose a deal because they have a lot of experience in that sector and therefore have a specific expertise that can be used to create value.  Sometimes firms are more opportunistic and the decisive factor is that it must be the right time to do a deal. And sometimes it's the ability of a team to take a company that manufactures in a high cost area and to transport it to a lower cost environment that constitutes their specific expertise. 

‘So, in general terms, we are looking for deals and successes that a firm has had in the past, that it can bring to bear in the present and the future to make a company perform better and therefore to generate returns.'

What would put you off investing in a fund?
‘I think that a firm that had a lot of turnover would be a problem. A firm that seemed to be run like a dictatorship with one overly dominant person or a firm that is just too top-heavy would also be a concern. A firm needs to have a very healthy and open investment process among its partners and staff and that cannot happen if it is overly centred around one individual. If a firm hasn't developed, hasn't grown, hasn't added people from below, I think that could easily jeopardise the way it will perform in the future and therefore our decision to invest with them.

‘If a firm had had too many deals that had lost money that would obviously be a problem. I also think if a firm seemed to have put too much of one fund's capital into a single deal we would have a big problem with that. Equally, if a fund has put too much of its capital into a single industry, unless of course that fund is industry specific, we may be put off investing with them. I think those are some of the things that would alert us to be careful.'

Are there any sectors or regions that you would not invest in?
‘We don't include emerging markets private equity in our fund of funds portfolio.'

Are there any sectors or regions that you see as particularly promising at the moment?
‘Our view is that private equity is a very long-term asset class. Money goes out over five years and it comes back over five years. It is not an asset allocation game. In other words I think our model portfolio that we talked about earlier should generally be our model portfolio on a relatively static basis. We might increase venture again when we get a little more positive in that area, but basically the model is pretty consistent.'

What advice would you give to a new investor in private equity?
‘My advice to anybody investing in private equity is to do two things. Have diversification, and demand the same amount of professional management in private equity that you would apply to any other asset class.'

What do you consider to be the biggest issue in the private equity industry at the moment?
‘I think that one of the bigger issues at the moment is the debate over transparency and mark to market. I don't know which way that debate is going to go but my bias is that I have no problem with the fact that private equity is not marked to market. In fact we think that one of the positives of private equity is that people approach it on a long-term basis. When you start trying to force people to worry about marking their portfolios to market and about what the value of their portfolio is at any one time, you distract from the benefits that you get from approaching the asset class with a long  term horizon.

‘When I talk to our investors and I contrast private equity to public equity, I explain that one of the negatives in public equity, as far as I'm concerned, is that every CEO of a public company is constantly worried about their quarterly earnings. I think it's far more positive to run your business by thinking about the next three or four years, not what is the best thing over the next three or four months. And if one pushes private equity firms to worry about mark to market, one is pushing them to worry about short-term results.'

 What changes do you expect to take place in the private equity industry?
‘I think that US firms will continue to do more deals in Europe. I think that it will be interesting to see what happens with the disclosure debate. I am also interested to see how the increasing number of consortium-led transactions will work out. It will definitely be interesting to see whether any problems will arise further down the road for these teams of two, three, or four private equity firms, who have joined forces to complete mega-deals.'