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Institutional investor profile: Alex Scott, senior investment manager, West Midlands Pension Fund

Scott on the opportunities emerging in PFI and infrastructure funds, on picking the wheat from the chaff and on the importance of diversification.

The West Midlands Pension Fund has £4.7bn under management and has been investing in private equity for around 20 years. The pension fund currently has a target allocation for private equity investments of between four and five per cent but plans to increase this to between five and ten per cent. The current portfolio represents 3.9 per cent of the pension fund’s assets. West Midland Pension Funds has two investment professionals dedicated to making private equity investments including Scott who has worked for the organisation for six years. He previously invested capital on behalf of high net worth individuals at Gartmore.

Why do you invest in private equity?

We first began investing in private equity back in the 1980s. At that point in time we were mainly investing in US venture funds with the aim of generating out sized returns. Today, we also invest in private equity in order to try and achieve some diversification. But our primary motivation is still to generate higher returns for the pension fund.

What type of investments do you look for?

We invest in the UK and Western Europe and also in the US. We invest across all stages, right from early-stage venture through to large buy-outs. We tend not to invest in many funds with a specific industry focus but we do cover a wide variety of investment approaches including development capital and buy and build strategies. We prefer not to take big bets on any particular sector or focus but we do tilt the portfolio to a certain extent.

What size of investments do you typically make?

We are making commitments of between £5m and £15m at present.

How many investments do you typically make in a year?

In the past three years we have made between eight and 15 investments a year.

How do you go about putting your portfolio together?

From a top down perspective we look at what our split is going to be between the US and Europe. The current balance is weighted 60:40 in favour of Europe. We then look more closely at the type of investment strategies we wish to pursue within these two primary geographies. The US is relatively straightforward in terms of a basic venture / buy-out split. In Europe we also have to follow the additional process of deciding how much we want to invest in single country funds and how much in Pan-European strategies. In Europe we currently allocate approximately 90 per cent of our assets to buy-out funds and ten per cent to venture. We have a reasonable mix of country focussed and broader regional funds.

How do you hear about good investment opportunities?

The pension fund has been investing in private equity for about 20 years so all the placement agents know us. Any GP looking to raise a fund would probably come across us at some point. On the other hand we also have a large network of informal contacts within the industry. We tend to hear about funds coming to market in advance of their official launch and where we aware that a fund will be in high demand we are able to proactively approach that fund.

How do you conduct your due diligence?

We don’t have the resources of a fund of funds manager, so while I wouldn’t say that we take short cuts, we do have a very targeted due diligence process. We try to decline funds as early as possible in the selection process and then really to focus our efforts on those funds that we think could be worth investing in. We then try and highlight the main issues that could potentially represent a stumbling block for us and focus our efforts on overcoming those.

What do you look for in a private equity manager?

We are looking for all the same things that everybody else is looking for. We like to see a solid track record in a team that has demonstrated that it can work well together. We like to see a thoroughly cohesive team with a coherent investment strategy that fits with the skills held by the team and the team’s track record.

What would put you off investing in a fund?

There is nothing particularly difficult about turning bad funds down. The difficult bit is selecting the funds that are really going to excel from the vast milieu of reasonably attractive funds.

What is your appetite for first time funds?

We will certainly give first time funds a fair hearing. We have backed them in the past and no doubt we will again. If the principals of a first time fund have worked together before and can demonstrate that their proposed investment strategy reflects their track record then we would certainly be interested in hearing from them.

What do you consider to be the most exciting regions or sectors going forward?

Not everybody would strictly consider this to be a private equity strategy, but we are currently very interested in PFI and infrastructure funds. Our expectations with regards our private equity returns have come down slightly and we will be very happy, going forward, if we can generate between 15 per cent and 20 per cent net. If PFI and infrastructure can offer us a comparatively safe return at between 12 per cent and 15 per cent, then right now that looks very attractive to us indeed. It seems to be a road that a lot of other investors are avoiding simply because it is a little off the beaten path and because there are some perceived political risks involved. I believe that it is an area that is currently under supplied in capital and I think there are some real opportunities there.

What advice would you give to a new investor in private equity?

The most important thing to remember for a new investor in private equity is diversification.

You have got to diversify by stage and you have got to diversify by vintage. Those are the lessons that a lot of new investors in 1999 and 2000 didn’t heed.

What do you consider to be the main issue in the private equity market at the moment?

The biggest issue and the biggest concern in the private equity industry are the types of returns that we are likely to get going forward. The 1990s was a great era but we are going to get some very disappointing vintages from 1999 and 2000. All we can do at the moment is to wait and see how much returns are going to go up through this side of the cycle.

How do you think the market is going to evolve going into the future?

I think investors are certainly getting more sophisticated and that is a trend that I think will continue to evolve. I think the market is going to broaden and deepen even further and I think that we will see more groups following specialist strategies. Basically I think that the market will continue to mature as it has been.

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