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Institutional Investor Profile: John Hess, Chief Executive Officer, Altius Associates01/06/2005. Source: AltAssets. 
John Hess on due diligence at private equity advisor Altius Associates, his firm's conservative investment approach and why he thinks few clients are better than many. Altius has a mixture of discretionary and non-discretionary clients, which include the California State Teachers' Retirement System, Teachers' Retirement System of Texas, Danish pension funds and UK institutions.  Hess set up Altius in 1998 out of Helix Associates, a specialist private equity placement agent recently acquired by Jeffries Inc. He had been approached by three institutional investors with whom the firm had had long-standing relationships asking for assistance in setting up private equity programmes on a formal basis. Altius was created to provide them with help in, amongst other areas, manager selection.
Altius has a mixture of discretionary and non-discretionary clients, which include the California State Teachers' Retirement System, Teachers' Retirement System of Texas, Danish pension funds and UK institutions. The firm currently advises on €4bn. The size of the individual programmes ranges from €2-500m.
What exactly does Altius do?
Altius provides bespoke services to institutions wanting to invest in private equity. We have a small number of clients and want to keep it that way, and this enables us to follow our partnership approach, which means that we work in partnership with our clients. If we had 50 clients we could not do that.
We currently have 12 clients, ten of which are big institutions. We consider family offices as institutional investors because they behave in the same way - one of our clients is a family office. Our clients are based in three regions: three are in the United States, eight are in Europe and one is in Australia. We have been working with three of our clients since the firm was founded, and the others have been added over the years.
Altius is a pretty top-heavy organisation, with 15 investment professionals worldwide, plus our finance and accounting team. Five of those 15 people have been in this business for between 15 and 20 years and managed institutional private equity portfolios.
Each of our private equity programmes has been individually designed for the client. Some of our clients came to us with fairly mature private equity portfolios and we worked with them to identify what they should do next. We usually do quite a bit of portfolio planning at the outset.
Other clients approached us with very little or no private equity and asked us to set up a programme from scratch. We also have clients who came to us with large fund of funds portfolios and wanted to start doing direct fund investments. Some clients simply want us to monitor their portfolios, while others want us also to advise on strategy, provide due diligence on funds in their portfolios and identify new ones that might fit. It really is a whole range of different services.
What kind of advice do you give to clients?
We always provide our input and suggest what we think a reasonable geographic and sub-sector allocation might be. When doing this we keep in mind that certain of our clients have their own restrictions on how much they can put into, for example, domestic private equity and how much they can put into international. If we feel that it is not consistent with what we think they should be doing we tell them, but it is up to our clients to make the final decisions.
In those cases where we build private equity portfolios from scratch we put forward a very comprehensive recommendation for what we think is feasible. Ours is a realistic approach focusing on quality.
Where do you invest?
For Altius choosing between investment opportunities is often an interactive process between the client and us. Our aim is to come up with something with which both of us are happy.
From a geographic standpoint, we currently have invested about 80 per cent by money in Europe and about 20 per cent in North America. By number of funds, the allocation has been 59 in Europe and 40 in the US. We have the capability of doing a small percentage elsewhere. The location of a client and how they feel about country exposure often influences the regions in which we commit or recommend they commit their capital.
The bulk of our recommended commitments has been in buy-outs. In terms of the number of funds, we invest 70 per cent in buy-outs and 30 per cent in venture and growth. However, these percentages have changed in the past and will change again.
In today's market investing is very tricky because of the access issue, particularly in US venture capital. Especially if your client has a very large amount of money, they might not have a whole lot of choice unless they want to step down the quality of manager, which we do not believe in.
We are pretty conservative and disciplined in what we do. We are not pioneers and we do not want to be pioneers. Someone once told me that pioneers are the ones with the arrows in their backs.
Which regions have good future potential for investments?
Over the past five years there has been a trend of putting more money into Europe. Most sophisticated investors have realised that there are great opportunities in Europe, and that has coincided with the larger pan-European funds increasing the size of their funds. Even the large US-based general partners have been investing increasing amounts in Europe.
We keep an eye on what is happening in Japan and Australia, the two developed Asia-Pacific markets. The East-Asian and South-East-Asian markets are also interesting - and changing - but so far we have not done anything seriously in those places. We do not think that high growth necessarily means great private equity returns. What we have recently been studying actively is Israeli venture.
In the Central European economies we pretty much take the lead from what the developed, experienced GPs do in those areas, rather than back individual country funds. Again, this goes back to our conservative approach. Although I think that in most places one can find a reasonable way to do things and be reasonably secure from a legal standpoint, we are not yet convinced by the risk-return profile of those markets.
What do you think of venture in Europe?
We have done a couple of small things in European venture and we will probably continue to back a couple of groups that we have been with for some time, but that will probably be about it for the time being. We recommend to our clients that they put 20-30 per cent of their portfolios into US venture but only if they can get into the top funds.
How many investments are you planning to make this year?
We do not have a target number. To date we have invested with 99 funds and have around 60 GP relationships. We will add to that number this year, but mostly with existing relationships. In the coming year we will deploy a significant amount of capital but it will not be with a whole range of new general partners.
How do you find out about good investments?
Just like other firms, we have a pretty complete database of the general partners. We also have good knowledge of who is in the market, who is coming to market and when, and we track that closely. Altius has its own system to do that.
Our approach is focused and we take a proactive approach. I could tell you today 75 per cent of our likely commitments over the coming two years. As for the remaining 25 per cent, there may be surprises but the majority is always planned well ahead.
This business is about word of mouth, networks and relationships - not just with the GPs but also with LPs and other players in the market, for example investment banks and investee company management teams. One important part of our strategy is to maintain active relationships with the GPs with which we have existing relationships. We closely follow what the GPs do for our clients. At least twice a year we formally meet every GP but it is a much more active relationship than that. We are on the phone once a month and ensure that the GPs let us know when something happens. The process often is very informal - we do not send out check lists and ask GPs to send them back to us once a month or something like that. We want to be thorough but user-friendly.
Through our research we typically know a general partner before we commence a more formal due diligence. Unlike some of our competitors we do not use questionnaires that GPs have to fill in. We have a check list of questions that we ask in interviews.
Before we conduct interviews, we get the numbers from the GPs and perform extensive quantitative analysis. This is the easiest part of our due diligence. The information we need at this stage includes returns, investment pace, the importance of individual companies to returns, number of professionals, staff turnover and more. Then we do our reference checks. We check references that are provided to us by the GPs but also, and probably more importantly, we check references from people who are not on that list. You have to know the right people because success in this business is driven by people.
The due diligence process is designed to give us confidence that the GPs are actually doing what they say they are doing. We are looking for the ability of the GP's team to work well with their investee companies.
We also compare each GP we look at with its peer group - in terms of size, team and strategy focus and returns because in our view you cannot look at any one GP in isolation of the competition.
What makes a good GP?
They produce good returns consistently, it is as simple as that. The alignment of interest within the team is key, as is the alignment of interest between our clients and the GPs. A good GP typically invests quite a bit of its own money into its fund and has a remuneration structure that rewards heavily on success. We do not like one-man shows. It is the team that counts.
What would put you off investing with a GP?
Too great an increase in the size of their fund would put us off. Also, we would be unlikely to invest with new teams whose professionals have not worked together before. We believe that there is always a new-fund risk, even if the team has worked together, simply because managing its own thing raises different pressures.Deviation from strategy would be another reason. Or too much concentration in one industrial sector. Sometimes it can be a sense that a team's structure and strategy are inappropriate for the world we are facing over the next few vintage years.
In your opinion, what issues are currently affecting the private equity business?
At the moment we are in the middle of a feeding frenzy with demand for high-quality private equity funds. This is as high as I have ever seen it - in 20 years. Multi-billion-dollar funds are turning away investors; this is extraordinary.
A very current issue is the level of debt being used to finance transactions. We have all had a pretty good time recently, with low interest rates and happy banks, but this is probably not going to last forever.
If you are a serious investor, it is important to maintain a disciplined process and not simply push money out of the door. It is better to be patient than to step down in quality.
But, there is always going to be a private equity business.
What advice would you give to new investors in the asset class?
There are two pieces of advice we would give. Firstly, if you cannot treat this asset class with a twenty-year time horizon, do not do it. If you want to generate genuine impact to your portfolio, it would then need to run through another full cycle, a ten-year cycle. In the 1980s and the 1990s, in Europe in particular, many new investors came into the asset class, gave it seven or eight years, found that the returns were not very attractive and then just stopped, but they missed a whole cycle of very attractive returns.
Secondly, stick to quality. If you cannot get into the top-tier general partnerships this time around, wait. It will take up to ten years before you begin to see any meaningful return information coming out of your portfolio. Be prepared to walk away from GPs you have been with if something changes.
Private equity returns tend to be cyclical and related to supply of and demand for capital. However, it is also virtually impossible to time entry into and exit from private equity owing to the limited partnership vehicle and the fact that investments are "private".
And do not worry about having to go in small at first. Almost all general partners value long-term relationships with investors and that is not going to change. It might be that you have to start with less than you would like. If you stick with quality, your patience will pay off.
What irritates you most about private equity?
Arrogance. There is no need for it.
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