In Depth

Q&A: The Global Private-Equity Outlook

Apr 22 2013 | 9:42am ET

Some suggest that times are tough for private equity. Lee Gardella is not among them.

Gardella is investment risk officer for Adveq, a Zürich, Switzerland-based private equity and real-asset advisor with about $5 billion under management. Founded in 1997, Adveq caters chiefly to institutional clients—insurance companies, public and private pensions, endowments. Adveq has traditionally delivered its services through a fund of funds platform, offering discretionary asset management, but has recently been branching out into separate accounts. Gardella spoke recently with FINalternatives Senior Reporter Mary Campbell about Adveq, the exit environment and opportunities in Europe.

Tell me about Adveq's investment activity.

Our investment activity in the United States is broken into two programs: Technology, which is primarily seed and early-stage venture capital, predominantly in North America, and opportunity, with an emphasis on control-oriented investing but heavily weighted toward small transaction sizes and turnarounds. In Europe, we are heavily weighted towards smaller transaction sizes with an overweight to turnarounds. Our fourth program is Asia, which is predominantly China and India, although we can invest in the other markets of Southeast Asia as well as Australia and Japan. The strategy is predominantly growth- and venture- oriented.

We also have two global programs: secondaries and real assets. Secondaries seeks to capitalize on our strong GP network by sourcing smaller individual deals. Real Assets is just coming off the drawing board and that is broken into three categories: agriculture, extracted resources and green power. If you look at the asset base of Adveq, $5 billion, a little more than half is geared to the States, in the two programs I mentioned initially, about a third is in Europe, the remainder is Asia and secondaries. Obviously, real assets will make its impact here very shortly on that number.

Adveq has invested, to date, in over 400 fund managers. What criteria do you use for manager selection?

On the return side, we assess the GP’s historical track record, deal sourcing, ability to generate premium exits and return potential for the existing portfolio.

On the risk side, our analysis is focused on the applicability of the fund’s track record, the fund’s investment team, operations, investment strategy, portfolio refinancing risks, and terms and conditions.

We benchmark our managers against their peers to make sure we're consistently selecting those managers we believe have the highest skill level for the amount of risk we're taking. That's a very generic way of saying it, but it takes shape and color when you look at specific strategies.

A recent example is the growth of distressed investing in Europe over the last year or two. There's been a flood of capital from the States particularly that has looked at Europe and said, "Bad banks out there with bad loans, sounds like a great opportunity set." It's been our experience that if we're going to lock ourselves up for several years there might be a more compelling way to take advantage of the low growth and the instability of the European marketplace, and our success in the States in the turnaround segment has given us the confidence that turnarounds is a better way to play the low growth of Europe. If you ally yourself with managers who have proven skill to improve the direction of a company in a turnaround providing a dramatic direction-changing of the business, your ability to earn outsize returns is quite compelling.

And I think it's paid off well for us. A lot of folks have committed capital into distressed credit trying to buy assets from banks and we decided to not join the crowd. The progress of our European turnaround investments has convinced us that we have made the right decision.

How many investments do you have at a given time and what size are they?

The number of investments varies by portfolio and strategy. I think it's safe to say that our European and opportunity programs are more concentrated than, say, technology and Asia. We believe that too much diversification can be a bad thing for us and for our industry. We try to be as selective as possible and eliminate the incremental decision of adding the 19th or the 20th fund—you're much better off if you're focusing on your top 12 to 15 ideas over a two- to three-year timeframe.

I've heard the current environment for p.e. exits described as difficult. Would you agree?

It depends, once again, on your marketplace. Europe is definitely slow and Asia has slowed down quite a bit from the pace it was at a couple of years ago, particularly if you look at the public side of things. In the States, we had a very strong exit environment up through the end of the year for our small buyout activity, and even the venture side was fairly robust. The first quarter did slow down from the fourth quarter, but all things being equal, it has not been a quiet period for exits here in the States from our standpoint. It hasn't been off the charts, but it hasn't been quiet either.

How involved do you get in the funds in which you invest?

We want to create value and assess each situation on its own merits and its own challenges, and thus you will probably see us be much more active the younger the firm and the smaller the fund. If it happens to be a bigger fund, more institutional in its makeup, with a lot of history, we will still actively dialogue with the manager on a very regular basis and we're always open to providing help and insights into the marketplace, given our unique global market perspective from the market data that we capture. In the end, we want to create value when it's needed but we don't want to be in the way; we want to pick our spots to get involved. We don't take advisory board seats on every fund that we commit to, but I can assure you that we will seek an advisory board seat for a first-time fund.

What is your approach to risk management?

Well, you have to make sure that you're building a portfolio that's consistent with the strategy and investment process clients signed up to. But at the same time, given the dynamic nature of private equity, risk management is also taking more risk but in a very informed, intelligent and prudent manner. Differentiating oneself in private equity requires an investor to act independently and thoroughly vet new situations or opportunistic situations and determine, "Am I going to get paid an attractive amount for the risk I'm taking?" We want the investment professionals to keep their eyes wide open and assess what's coming across their desk or what they're sourcing to determine whether or not there's unique opportunity that may not be apparent on the first page of the document you are reviewing or from the conversation you just concluded with a GP.

Private equity has the ability to fill voids where there is capital dislocation and where liquidity is at a premium in a segment for whatever reason—it could be regulatory, it could be capital markets, it could be just economic malaise—and we want to take advantage of it. The European private equity market has seen many traditional investors reduce their exposure over the last few years. It's been a great opportunity for us to put more money to work, to take advantage of lower valuations and unique investment opportunities. Although there has been a clear decline in private equity commitments in Europe, we have not slowed.

What area do you find most interesting in the current market?

That's a tough one, because I'll make enemies no matter what answer I give you. If you said, "You have one dollar to invest, Lee, where would you put it?," on a risk/reward basis, I am quite intrigued by what's developed in Europe. Overall capital commitments are down in Europe, and the bulk of capital going to Europe in the last few years has really gone to the more established, larger funds, pursuing larger transactions. Thus the sub-€500 million funds, outside of maybe a handful of GPs, are fairly starved for capital and it shows in the actual deal activity as well. So, I find the smaller buyouts in Europe to be a very compelling opportunity as a point to commit capital now.

In our European market assessment, we try not to get lost in all the headlines around the various euro issues, because the European economy is big, it's bigger than the United States, and it's a very deep, very broad, very diverse economy. If you were to align yourselves with managers of proven skill, it should be happy hunting. And we see that. If you look at the attribution to our underlying companies we've been very pleased by the progress of our companies both from a revenue perspective, and particularly from a cash-flow standpoint. At the same time, our portfolio has a risk profile that's much more conservative than the typical single private equity portfolio. And so, from a value investor perspective, maybe it's my DNA, but I think European control investing is an attractive marketplace.

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