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Institutional Investor Profile: Henry Potter, Senior Banker, European Bank for Reconstruction and Development28/09/2005. Source: AltAssets. 
Henry Potter on Central Europe, the Balkan states and why the European Bank for Reconstruction and Development has been very active in Russia recently. Potter joined the bank some ten years ago. He is now one of a team of three senior people who run EBRD's funds programme.  EBRD is an international financial institution with €20bn of capital under management. It was established in the early 1990s by a number of governments to further economic transition in Central and Eastern Europe. The largest single shareholder is the US government, with a ten per cent stake, while the EU countries together own more than 50 per cent. A host of other countries from all over the world, including Japan, Canada and Australia, also have shares in EBRD. The bank does not raise money from other institutional or private investors.
Private equity investing is only part of what the bank does. EBRD has a number of different investment and lending groups, and also sector-specific and country/region-specific divisions.
Typically EBRD invests between €5m and €50m per fund. The average is around €20m.
When did you start investing in private equity funds?
'In 1992 - we made two commitments. One was a London-listed hybrid investment trust for the Czech Republic that took several years - and management teams - to figure out whether it was a private equity fund or not. Another was a spin-out from a US government-backed investment programme in Poland that returned well over 2x and has gone from strength to strength since.
The bank sort of stumbled into private equity investing, making its first funds commitments opportunistically. At that point there was no private equity industry in Central and Eastern Europe. Since then we have evolved with the industry in the region. Over the past 12 years we have committed about $1.8bn to some 80+ private equity funds in the region.
Since the mid-1990s we have professionalised our funds investment process with dedicated staff and consistent methods. We now operate a proprietary database with 800+ direct investments by our funds that we think is a reasonable index of private equity returns in the region. We share the information annually at an investor conference - this year on 10 October - any LPs who are interested in our countries are welcome to contact us (Alison Shellum, shelluma@ebrd.com).'
Why is private equity important to your strategy?
'We are looking for ways to finance private companies in Central and/or Eastern Europe, both with equity and debt. We do most of our activities directly but also invest in funds.
Our main objective when investing in funds is to help create an institutionalised private equity industry. However, while our overall goal is developmental, the way we do our job is commercial because the only way to develop a well-functioning private equity industry is by showing sufficient returns. That is how you attract a sustainable institutional investor base. We try to back people who will do well and will further develop the industry.
Regarding other alternative asset classes, we have invested in a small number of property funds. Currently we are not looking at hedge funds because that market has not really emerged in the region yet.'
How has your investment strategy evolved?
'At the beginning we tended to do the larger direct investments ourselves and saw the funds as a way to access the smaller mid-cap markets that we could not efficiently serve, given that most of our staff were in London. Over time the private equity industry in the region has grown and funds are doing deals of a similar size to the ones we do. We increasingly co-invest with our GPs - and sometimes also take deals to them. We have realised some synergies, for example by arranging debt syndicates for LBOs sponsored by our GPs.
From a standing start in the early 1990s, we helped build a private equity ecosystem in the region. Now we are trying to replicate that in more difficult markets.'
What is your appetite for first-time funds?
'We backed a large number of first-time fund managers in the early and mid-1990s, particularly in the countries that recently joined the EU. Some managers performed, others did not. As they started to raise their next funds, we gravitated towards backing the more successful teams.
In these markets, we are more critical with first-time managers unless they have a particular angle or skill set, or are aiming at a segment of the market that we think is underserved. For example, we recently backed the first mezzanine fund in Central Europe.
In the more difficult markets - that is, the markets further south and east that are still underserved by private equity - we spend much time looking at first-time managers.
With our first-time funds we have to be very hands-on in terms of our monitoring. We are usually on the investment committees or at least observe the deals the firms are doing. If you are going to invest in first-time funds you have to devote resources to follow the GPs on a deal by deal, month by month basis. You also have to be prepared to co-ordinate with other LPs and shut the fund down if it becomes clear that something is not working.
It is always difficult to raise a first-time fund, and even more so in regions where the investment industry has no track record and large parts of the economy are emerging from government ownership. Even in difficult areas we regard it as part of our mandate to support promising new teams where possible.'
Which countries do you focus on within your region?
'Over half of our investments are in Central Europe. The majority of the other half is in Russia/CIS, and a smaller but growing portion is in the Balkan states.
In Central Europe the private equity market started earlier and with the countries' accession to the EU the political risk profile changed fundamentally. Yields are compressing, and the convergence story is increasing in credibility. As a result the value of businesses has been increasing.
The private equity market in Central and Eastern Europe is now much more institutionalised and mature, with fund managers raising their third, fourth and fifth funds. Many firms have developed operationally, building both track records and a quality investor base along the way.'
Is access already an issue in Central and Eastern Europe?
'Not yet, but it might happen soon. Some of the best performing GPs are getting to the point where they may be able to raise capital too easily - then it will be interesting to see if they have the discipline to really limit fund sizes to remain middle market and differentiated from the pan-European managers.'
What is your opinion on Russia?
'There is a massive opportunity in Russia and CIS because the growth is extremely fast and so is the pace of economic change. The private equity industry is still small measured as a percentage of GDP, and there is room for many new teams to develop the market.
Due to the emerging middle class the consumer-related industries have particularly good potential. Companies have the opportunity to create brands inexpensively, and investments can prove very valuable.
Returns can be better in Russia than in Central Europe. We have had some fantastic exits recently, not only in Russia but also in nearby markets such as the Ukraine and Central Asia. I can understand that many investors are still nervous because it is hard to predict what will happen in the future. Everyone will watch the upcoming Russian election carefully.
We have not seen many cases of portfolio companies suffering because of political or legal issues. There have been some examples, but in the context of a portfolio it has not been a major issue.'
What is your annual allocation to private equity funds?
We typically commit between €100-200m in our private equity programme a year. In 2004 it was around €200m, representing about six per cent of our total annual commitments. 2005 commitment volume will be similar or even slightly higher.'
How do you find out about good investment opportunities?
'There are more GPs in the region than you would think, and we know pretty much all of them. We are by far the largest funds investor in the region. In fact, we are in about a third of all funds that we know about. Every GP in the region knows us and almost every GP raising a new fund approaches us. Only occasionally does someone appear on the radar screen that we do not know.'
How do you conduct your due diligence?
'Like most of our peers, we look at the people and their track record first. Typically we have a number of one-on-one meetings to pre-screen before we invite the GP to pitch to our whole team. We always make a collective decision on whether or not to invest.
If successful, we visit the GPs in their countries. We also meet their portfolio companies, and not just the ones on the GPs' reference lists. We try to talk to other people associated with the companies such as third-party shareholders. The aim is to analyse the GP's track record focussing on the team's ability to execute their strategies.
With first-time teams we obviously have to pay a little more attention to the chemistry between the people, and we have to analyse how hungry they really are. We meet the people socially, have dinners with them, and travel with them. That helps us understand what makes them tick, what their personal objectives are and what it is they are trying to achieve. It is important for us to feel that they are around for the long term, not just a fund, and that they substantiate this with a financial commitment.
The due diligence process is more focussed when we invest with a team that we are familiar with from previous investments. Our monitoring often allows us to make an early decision on whether or not to back the new fund, even before they are out fundraising. The final decision then often depends on the terms of the agreement, succession issues, and the team's strategy going forward.
What are the most interesting industry sectors going forward?
'Telecoms is an extremely dynamic sector and continues to be a very profitable sector to invest in. The advent of leverage should change the landscape. Lower growth companies are now financeable with expensive equity. For example, I am starting to see an increase in manufacturing deals - for the first time I have found myself worrying about China when looking at investment proposals.'
How do you think the market will change in the future?
'We are starting to see some of the big pan-European buy-out firms coming into Central Europe, and they focus on the larger deals. My feeling is that the local GPs will end up as mid-market specialists, leaving the large end to the pan-European or global buy-out firms.'
What advice would you give to a new private equity investor in the region?
'When you look at the GPs you have to understand that their track records have been built with investments that are almost certainly not going to be replicated over the next few years. Deal profiles are simply changing too fast. You always have to look forward, understand the market, and evaluate whether or not your GPs have the skills to evolve.'
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