Pension fund allocators often complain that hedge fund and private equity managers just don’t understand the way they think. That’s not a charge that can be levelled at Jens Bisgaard-Frantzen. The chief executive officer of Private Advisors UK LLP, the new European outpost of private equity and hedge funds of funds manager Private Advisors LLC, joined last year from ATP Private Equity Partners, part of Denmark’s largest pension fund investor, which he established in 2001. Before that he was making direct and fund of fund commitments for pensions and insurance giant Sampension.
That experience sits happily next to that of Private Advisors’ founder and managing
partner, Louis Moelchert, Jr., who managed the University of Richmond’s endowment for over 25 years, diversifying into alternatives in the early 1980s. The firm, which manages $3.8bn (€2.5bn), 80 per cent of it institutional money, certainly seems to have earned the right to claim a “buy-side perspective”, as it does on its website.
“That means that we are not only making an investment decision, but living with the outcome of that decision over the long-term,” says Mr Bisgaard-Frantzen. “The 19 equity holders within the group invest 95 per cent of their personal wealth in its funds.”
Indeed, it was a disagreement over alignment of interest that precipitated Mr Bisgaard-Frantzen’s departure from ATP. He had always wanted to open up ATP’s strategy to third-party investors, but when push came to shove the idea was quashed for fear that it would be a distraction from managing the money. By contrast, Mr Bisgaard-Frantzen felt strongly that third-party commitments would put extra pressure on his team to make the most robust investment decisions and deliver the best performance.
When he joined ATP, Mr Bisgaard-Frantzen got a clean sheet of paper and a request to build a business plan for a $5bn, five-year commitment to private equity. His first
resolution was to be absolutely clear about the objectives of the allocation – to return 15-18 per cent per year – and to give clear mandates to each manager, across the portfolio, to ensure that those objectives were met.
“Our view was that we should focus on managers who could create long-term returns,” says Mr Bisgaard Frantzen.
Ebitda growth
The team decided that there were essentially three sources of private-equity returns - Ebitda growth, multiples expansion and leverage – but that only the first of these could offer sustainable long-term value at acceptable levels of volatility. That led to a focus on small-cap and mid-market funds, with a smattering of sector-specialist large buyout funds (LBO).
As a result of this choosiness, ATP’s commitments stopped just shy of $4bn as it watched other institutional investors write giant cheques for headline-grabbing LBOs. But the upsides were twofold: closer, less diluted relationships with GPs; and better diversification away from ATP’s public equity allocation.
The diversification issue is key, because, as many reports have shown, private equity is an alpha game. Not only do top-quartile funds significantly outperform the median (and
public equities), they also have a 43 per cent chance of making the top quartile with their next fund. By contrast, the next offering from a bottom-quartile manager has a 60 per cent chance of performing even worse.
“When we translate the concept of alpha into real life, it’s about growing the earnings of a company through operational improvements, rather than creating returns through financial engineering,” says Mr Bisgaard-Frantzen.
The liquidity contraction that has gripped markets since last summer seems to be bearing that philosophy out, and could put Private Advisors into a good position to exploit increasing, but changing, pension-fund demand for private equity.
Funds of funds
The latest Russell Investments Survey on Alternative Investing predicts an increase in the average European pension fund private equity allocation of 1 per cent to 5.5 per cent by 2009. But it also shows a significant increase in those who prefer funds of funds to direct investment – a trend likely to pick-up if allocators spurn LBOs.
“Whereas pension funds with limited resources are able to invest direct in LBOs, it is much more difficult for them to establish good relationships at the smaller end of the market,” Mr Bisgaard-Frantzen observes.
He knows the feeling: at Sampension he originally ran direct minority stakes in Danish firms, but when it was decided to diversify the strategy the workload quickly spiraled out of control. He began to build a sector-specialist fund of funds portfolio instead.
“It makes a lot of sense to use funds of funds as an outsourcing partner,” he explains.
Across both hedge funds and private equity Private Advisors is value-oriented and biased towards lower-volatility strategies with minimal leverage and low net exposures or public-market correlations.
On the private-equity side – which accounts for about one-third of assets under management – that translates as a family of US small-company buyout funds of funds and some co-investments. The average underlying fund manages just $250m in transactions with enterprise values of less than $150m. The firm has always held that this segment of the
market offers more modest Ebitda purchase multiples, companies that can be purchased in less efficient capital markets, and greater opportunity to improve operations – all pages from Mr Bisgaard-Frantzen’s textbook.
Private Advisors US Small-Cap III is currently being raised – but interestingly, it is in fact the firm’s fourth fund.
“The first fund was a combination of venture and buyout, but the fundamental approach made it harder and harder to look through the black box associated with a lot of venture deals,” explains Mr Bisgaard-Frantzen. “In the mid-90s when a new technology came to market there would be one or two venture funds supporting it. Today there are 20 – but there will still only be two successful ones, so good, fundamental analysis is more important then ever. I wouldn’t completely rule it out, but I think the venture model is more-or-less broken.”
On the hedge fund side the fundamental, bottom-up approach to manager selection excludes “black-box” strategies like quant funds, global macro or CTAs – and favours managers who are themselves fundamentals-focused.
US-focused products
There are five US-focused products: Low-Volatility Multi-strategy (previously called Absolute Return) is focused on fixed-income like risk-return profiles, low leverage and residual equity beta; Long-short equity is biased towards bottom-up stockpickers,
mixing value, growth and catalyst styles; Diversified combines strategies from those first two funds with a slight tactical tilt; Income allocates to managers predominantly investing in publicly- and privately-traded corporate debt securities, asset backed securities, and privately-negotiated debt transactions; and distressed invests with managers specializing in traditional active distressed equity, capital structure arbitrage, liquidations, direct loans, long-short debt and asset based transactions.
The funds have around 20-22 managers and maintain a low turnover because any tactical decision is taken within the context of the firm’s long-term strategic philosophy.
“We do take a long-term macro view,” says Mr Bisgaard-Frantzen. “At the beginning of 2007 that led us to increase our allocations to more short-biased and distressed hedge fund managers – Private Advisors published a white paper on the subject, predicting that there would be problems, and towards the end of year that decision started to come good.”
The firm looks particularly strong in this area, not least because it offers key opportunities to synergise across the hedge fund and private equity divisions: “There is a high degree of convergence in this area,” says Mr Bisgaard-Frantzen, “and the firm is
structured to facilitate information flow.”
As such, the five-year macro view on the private equity side also holds that the next 2-3 years will see the best value in distressed opportunities.
“But we don’t allocate to these funds for the short-term, get a good run and then redeem,” says Mr Bisgaard-Frantzen. “On the hedge fund side, the process is much more focused on managers’ ability to generate good risk-adjusted returns over the longer-term, and on the private-equity side, the full fund cycle will take in a period of 10-12 years, and you cannot predict how the business cycle will play out over that length of time. It wouldn’t make sense to go 100 per cent distressed, get a good run for 2-5 years, and then suffer at the tail-end: we need to be able to deliver cash flows in years 8, 9 and 10.”
European profile
Looking at his own role for the coming years, he says that he will focus on building up the team in London and raising the profile of Private Advisors in Europe. He sees Continental Europe as a key market, but also notes that the more sophisticated institutional investors in the UK are now beginning to look beyond the usual names for private equity funds of funds.
“We know some of the large consultants from our work in the US,” he says, “and now that we are establishing a London office we should be in a much better position to address that market here.”
But his is far from just a marketing office. Clients have asked for a broadening of the firm’s US-focused strategies globally, and Mr Bisgaard-Frantzen intends to welcome a
couple of hedge fund professionals by the end of the year. Meanwhile, FSA approval has come through and, 10 years after Private Advisors was founded, the firm is looking to raise its first non-US small-caps buyout fund. It will give Mr Bisgaard-Frantzen a chance to hook up with some old acquaintances again.
“It’s not in my nature to say lots of nice things about myself,” he says modestly, “but I’ve had a good reception from people I’ve invested with through ATP. I was invited to one of my former GPs’ annual meetings, and I did say, ‘Please consider me next time you are fundraising.’ He said, ‘Once a member of the family, always a member of the family.’ I think that’s a strong endorsement. ATP was clearly a team effort, but because I was there from the start setting out the strategy, GPs associate me with that philosophy and understand that’s what they’ll get with me at Private Advisors.”
