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Institutional Investor Profile: D Brooks Zug, Senior Managing Director, and George R Anson, Managing Director, HarbourVest Partners23/11/2005. Source: AltAssets. 
D Brooks Zug and George R Anson on long-term relationships with fund managers, brave steps, and why they think that fewer funds can be better than more. HarbourVest runs US-focused funds of funds, international (non-US) funds of funds
and mezzanine funds of funds. The firm is also very active in the area of direct
investments. It employs 141 people - 56 of which are investment professionals
- in offices in Boston, London and Hong Kong.
On average, HarbourVest
makes between six and eight new commitments in Europe and Asia, and at least twice
as many in the US a year. The current annual allocation is about $750m to Europe,
$150m to Asia and $1bn to the US market.
HarbourVest is currently in
the midst of committing its latest US fund programme, HarbourVest Partners VII,
which closed on $4.5bn in 2004. HarbourVest Partners VII consists of a $2bn US
venture fund of funds, a $2bn buy-out fund of funds and the firm's new $500m mezzanine
fund of funds. In aggregate, two thirds of this fund programme are now committed.
On the non-US side, the firm has completed investing its fourth international
fund of funds, the $2.8bn HarbourVest International Private Equity Partners IV.
The major part of the $2.8bn has been invested in/committed to Western European
buy-out funds, while $400m of it have been allocated to the firm's direct investment
programme.
HarbourVest's fund of funds programmes invest in both primary
and secondary deals.
How
has your strategy evolved over the past few years?
'In our international
fund programme we have come to emphasise investments in buy-out funds, at the
expense of venture funds. Today the programme consists of 85 per cent buy-out,
15 per cent venture. In the previous fund venture funds accounted for about 30
per cent.
Also, we now focus more on the established economies. We have,
for example, reduced the number of relationships in South Africa and Latin America.
Our Asian programme has been refocused to include only buy-out funds in Japan,
South Korea, Hong Kong and Australia. HarbourVest International Private Equity
Partners IV consists of 80 per cent commitments/investments in Europe and 20 per
cent in Asia-Pacific and Latin America, compared to the previous fund, Fund III,
where we had about two thirds invested in Europe and one third in Asia-Pacific
and Latin America.
The most important thing that we have learned about
investing in parts of Asia, South Africa and Latin America, is that it is so much
harder to quantify all the risks involved in an investment - particularly the
macro-risks. For example, we had an investment in Latin America during the Argentine
dollar crisis, which had a significant negative impact on the fund investment
we had there; and the rand-dollar relationship in South Africa had a material
impact on the dollar returns that we had out of South Africa. No amount of hedging
or tactical planning will ever make up for the factors that we cannot control.
That is why we have tended to refocus our energies on more established economies,
but we will always continue to look at the other regions, especially Eastern Europe.
However, our overall strategy is not to have a presence in every single
market. Diversification is important to us, but I would rather diversify across
top-performing managers in fewer regions than compromise the quality of managers
for the sake of a broader geographical diversification.
We feel that
the whole fund of funds industry is suffering from the accusation that fund of
funds managers tend to over-diversify and end up with portfolios that look like
indices. So how do you outperform? The simple answer is by picking those funds
that are only in the top quartile - and that means you have to be highly selective.'
What is your opinion on the European venture market?
'I
think that the European venture market is still recovering from the dotcom crash.
From our perspective, we are continuing to invest in it, but on a much more selective
basis. There are some groups that we have invested with for the third or fourth
time, and they deliver good returns.
With our European venture investments
we focus on countries with a strong entrepreneurial culture, where the capital
markets are reasonably strong and where there is a good body of experienced fund
managers. That means, we regularly end up focusing not necessarily on the biggest
economies. We find that the most entrepreneurial economies are Italy, Scandinavia
and also the UK - the British market has been very competitive, but it delivers
very consistent returns.'
What is your typical bite size?
'In our fund of funds programme our average venture fund commitment is around
the €25m mark, while the average buy-out fund commitment is probably €60m per
fund. I think we feel pretty comfortable at that level. The largest fund commitment
that we have ever made is €120m and the smallest - at least in recent history
- is €17m. It all depends on the opportunity, whether it is a big buy-out fund
or a small mid-market buy-out fund.
As we are one of the largest investors
in just about every fund we are investing in, we almost always have a seat on
the advisory boards - that is part of our strategy. We want to stay close and
exercise as much as we can an active management strategy.'
Do you
expect the sizes of your funds of funds to increase significantly in the future?
'If we do increase the sizes at all it will only be a modest increase.
I do not think we are going to slavishly follow the market, but, in some ways,
the market does influence what we do. This would also be true if fund sizes go
down again - then we would expect modest decreases in the sizes of our funds of
funds.'
Is access a problem for you?
'The advantage of
our long-term relationships with fund managers is that access has never been an
issue for us. When we started out access was not a problem in this industry. Our
long-term relationships almost guarantee us a position in the partnerships in
which we want to be. Over the past five to ten years we have been increasing our
share in those partnerships.'
Do you invest more capital into direct
investments today than in the past?
'Yes. We have always done direct
investments and although the number of deals probably has not increased, the unit
size has crept up. More significantly than anything else, we have increased the
size of our direct investment team. We now have four people in London and 12 in
our Boston office dedicated to those investments. That has enabled us to do better
deals in that area and also to feel more confident about investing proportionally
more capital in direct investments. The past four or five years have proven to
be a good time to be investing in companies.
We do not regard our direct
investments as co-investments. It is more that we partner with many of the fund
managers that we invest with. We normally co-lead the deals, but in a subordinate
position. If a mid-market buy-out group has an equity requirement of $80m and
the fund manager wants to invest $50m we would take the remaining $30m. The alternative
for them would be to speak to one of their competitors, who wants to share the
deal 50/50 and wants to share corporate governance and everything else, whereas
we are quite happy to take the junior role.
We would not do any partnership
investments with the objective of securing direct investment opportunities. Every
fund investment we make has to stand on its own two feet, and so does any direct
investment.'
What do you look for in a good private equity fund manager?
'In short: people, process and performance. It is a very good starting
point when a fund has been around long enough to have a performance record. For
those funds that have not been around for that long, people and process are even
more important - and people and process are very important in every fund.
Furthermore, a good private equity or venture capital firm should have
a broad mix of financial, operational and industrial skills in-house. Many people
say you have now got to be all-operational, but we believe you also have to have
people at your firm who know how to structure and execute a deal. That is what
this business is about.'
What would put you off investing with a fund
manager?
'Lack of performance, obviously. Change of strategy, high
turnover of people, unbalanced economics in a team and too large a fund are all
factors that can lead to us rejecting a new fund investment. Unbalanced economics
is a big one for us. We like to see a team that distributes rewards broadly within
the organisation, because that is what keeps teams in place.
One of the
hardest things we have to do now, particularly in the US, is drop some managers
where the top-quartile performance of previous years is attributable to a different
group of people from the team currently in place. We would drop them if we believe
they are not as good or proven as the old teams. Another thing is if they are
trading on the brand name while still looking to charge premium economics to their
investors - the 30 per cent carry and two and half per cent management fee. From
a business point of view that is sometimes not the right thing to do. We have
had to make a couple of hard choices like that, with some top names in the market.
Some other investors congratulated us and welcomed that at last someone had the
nerve to leave a top brand. The problem is that once you have done that it is
almost impossible to go back and invest in one of the team's future funds. You
have made a decision for a long time, it is not easy.'
Would you consider
investing in first-time funds raised by first-time teams?
'That is
probably a little too extreme. We would invest in a new firm where at least some
part of the team has been in business for a long time. We are more likely to invest
with a new fund manager if we know a member or members of the team. On a couple
of occasions we have invested in an individual who we have known for some time
and who has teamed up with some other people who we have not known, but that is
a real exception. As a general rule, we like to invest in a firm that has been
around for a long time.'
How do you conduct your due diligence?
'We are in contact with our fund managers all the time, either we meet
them or we talk to them on the phone - and that is not just when they are fundraising.
With due diligence on an existing team you are not going back and taking reference
calls. Instead we look at what has changed from the last time we invested with
these people, either in their own internal organisation or out in the market place.
It is good logical evaluation. The hard part is to strip out the emotional attachment
you have with groups and make an objective decision on whether you want to invest
with them again.
Is there much of a relationship between the US and
the international fund of funds side in your firm?
'It is very much
one business. All of us have to be up to speed on what we are doing in terms of
investment and how the portfolio is performing, on both the US and the international
side.'
Are you worried that there is too much capital coming into
the asset class?
'Although we talk about what a growing asset class
private equity is, if every pension fund in the world contributed ten per cent
to private equity we would have a real problem on our hands. Having more capital
available for investment in private equity is not always a good thing. It is like
eating too much.'
What advice would you give to a new private equity
investor?
'Get good advice. Use consultants and probably start by
investing through a fund of funds programme. Be patient: you are not going to
see the benefits of your private equity programme for at least five years.'
What advice would you give to more experienced private equity investors?
'Consider hard choices. It is easy to continue to believe in the mystique
surrounding certain top-brand names, even when the team that has built the reputation
has left.'
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