Dan Aylott, Cambridge Associates
Dan Aylott is Head of European Private Investments at Cambridge Associates.
This is a Fund Shack ‘private chat’ about the large opportunity set in the European private equity market, from buyouts through to venture capital, with a focus on growth strategies in all these markets.
Transcript:
Ross Butler:
You’re listening to fund Shack. I’m Ross Butler. And today I’m speaking with Dan Aylott managing director and head of European private investments at Cambridge Associates, where he’s responsible for EMEA private equity and venture capital research. Dan works with clients to help them build, manage, and monitor their private market allocations. So he has fantastic insight into the industry and some unique perspectives on the market, which he was good enough to share with me. Enjoy!
Ross Butler:
Welcome to Fund Shack. You’ve been at Cambridge associates for a fair while now, but I believe you’ve just undertaken it a new role. Can you tell us a little bit about that?
Dan Aylott:
Yeah. Hi Ross. And I’m very happy to very actively speaking to you today. I’ve been at Cambridge just over nine years. I’ve been in the industry now for a whopping 20 years. I started with a private equity team in year 2000. I joined Cambridge nine years ago to work with clients on their private markets portfolios. So for the first sort of eight and a half years at Cambridge, that’s been my primary focus. And then last year, my role changed slightly. So I now I’m head of European private investments, which entails me having a mix of responsibilities.
Dan Aylott:
My primary responsibility going forward is to cover the European private equity and venture capital research function here, which means that, were tasked with finding best ideas and high conviction managers. But for our clients, I’ve brought some client relationships with me. I continue to work with some of our key clients at the firm. And yeah, excited by the change. Even when I was working predominantly with clients, I was often, doing manager due diligence and looking and scouring for ideas for, for those clients’ portfolios. So this is just a, really an extension to, to that role. But I’m excited. We’ve got a, a large opportunity set, I think, in, in European private equity and venture where we’re adding resources to the team so that we can we can cover all of those opportunities. And I’m very excited by what lies ahead.
Ross Butler:
What’s particularly exciting. You, what parts of the market do you really like the look over at the moment?
Dan Aylott:
I’m passionate about all parts of the market really, but I think for us at the moment, there’s a real desire and hunger to look for growth strategies, and that can be anything from very early stage venture through to growth, equity and buyouts that have a growth slant to them. We’ve long been talking about the benefits of growth and how growth is the predominant factor in achieving outsize returns in private markets portfolios. That’s where a lot of very interesting ideas are coming from right now. Certainly, in the venture space the ecosystem there has really been growing and expanding in Europe in particular, there’s always been a very sort of well-established U S venture market as everyone obviously knows.
Dan Aylott:
I think Europe has often been thought about as being in the shadows of the US and even potentially China and Asia to some extent, but I think recently we’ve seen some strong performance coming out of Europe and some the manager universe, if you like, sort of expanding in all directions with many interesting strategies for us to, to look at and to answer, consider for our clients.
Ross Butler:
Tell us a little bit about that if you would that. Can you quantify the, the growth of European venture in the last half a decade or so?
Dan Aylott:
In the last year alone, there was $20 billion raised by European VCs, but there was 40 billion invested in Europe. So that gives you a sense that the market is very attractive and is attracting investment from all over the world. In fact, and that’s really feeding into a very buoyant and a flourishing ecosystem. So it’s definitely an area of growth and, and definitely an area where we’re seeing lots of very interesting opportunities There’s always been well-established firms in, in the venture space in Europe for a long time. We’re seeing a lot of managers spinning out. Operators, people who’ve run or worked in senior positions in technology companies and have done very well made a lot of money, want to continue to invest in the space. Joining forces with investors to create new firms that I think are particularly interesting.
Ross Butler:
Then what underlies this growth? Was it just a question of time in the market, because for a long time, European venture capital it underperformed and it was, and it was subscale and perhaps to a degree, it is still subscale, but, but what underlies it’s, it’s, it’s recent growth?
Dan Aylott:
There’s a number of things that you might want to point to. When I started in the industry 20 years ago, roster the European venture landscape was really not on the map. I was joking with a colleague this morning about how, diligence used to be done. Data rooms came in the form of a, of, of envelopes packages in envelopes that were sent to you via the post. So that, that age has me somewhat, but the venture capital market obviously had been impacted by the.com crash. There were very few European venture firms last minute.com perhaps was, was the most famous impacted obviously when, when the crash happened. So really nowhere on the map where performance really wasn’t, wasn’t there either.
Dan Aylott:
And it takes a long time in venture for performance to come through. I think since the financial crisis, there’s several things that have happened. We’ve been in a very low-rate environment for a long time. So people have been seeking growth and seeking alpha from different areas of their portfolio. And I think that, venture and growth has been an area that has if that, that, that growth and that innovation that can’t be sort of captured anywhere else in, in portfolios. I also think it became a little bit uncalled to be a banker or or go into financial services after the last financial crisis. And there was an impetus perhaps, but for young people coming out of universities, strong tech universities to think about doing something different.
Dan Aylott:
So there’s a number of factors I think that has fed into it. And I think as, as we’ve seen performance improve in Europe and we have some statistics that show over recent horizons one year, three year, five year European venture growth has actually performed strongly versus the U S and Asia. And I think as that performance has started to come through its European venture has caught the attention if you like of investors. And from that, and the more capital that flows into the, into the industry, the more opportunities that it creates.
Ross Butler:
That’s all directionally very positive. But the venture managers that I speak still tend to complain about a relative lack of capital in Europe compared to their us counterparts. Would you, would you agree with that?
Dan Aylott:
I mean, I would. I don’t know how, what the best way of saying it… It is… Underserved relative to other markets. Something like10% of jobs in the US are currently within companies that are VC backed and the equivalent number in Europe is 1% that is still quite concentrated around markets like the UK and Europe. But what happens with LPs generally is that there’s a lag. So the PE investors see performance coming through and then think, well, okay, this looks interested. I’m now going to start committing capital to these types of strategies. And so that’s what I think we’re seeing here is that we were convinced Cambridge that European venture and growth is an interesting space for our clients to commit capital finding great ideas for them to do so. There’s some convincing to be done around European venture capital and growth for certain investors, because historically performance in Europe has been difficult.
Dan Aylott:
The exit environment has been a little more challenging, and that’s being addressed. I think in some ways, here in here in Europe, there are changes to the regulations around listings, for example, that might make it easier for technology companies to go public. But that’s just one example, but there are, there are changing in a positive direction in Europe. And so, I think it’s just a matter of time for people to continue for investors to continue to see that positive momentum coming through. And I think that the capital will continue to flow into it. Abut I think it’s today, or you’re right. I think there’s still, more to go for. I think the overhang of capital in Europe is much less than it is in Europe. sorry, then it is in the U S apologies. Yeah. so, there’s some interesting dynamics in, in Europe that were, that we’re keeping our eyes on.
Ross Butler:
I’ve heard one hypothesis, which is that in fact, if more capital accrues to European venture and growth capital, you might see returns increase relatively counter-intuitively because of that sub scale element to the industry. Is that something that you would agree with, or do you think that the more capital that flows in will, will eventually kind of push returns down?
Dan Aylott:
Yeah, it’s an interesting thought. I mean, the fundraising market at the moment is really, really frothy. And boy, there’s lots of capital being raised everywhere, not just in Europe. I think the general perception is that the more, that more capital that gets raised, the more likely it is that returns will tail off. So it depends, I think you still have to keep disciplined. I think the key is for the managers that raise the capital that are successful at raising the capital stick to their strategies and, and remain disciplined in, in the areas that they’re good at and the areas that they can, they can produce, the attractive returns for their clients. And I think if managers can do that then, then, then returns will still be maintained. I think, as I’ve said, I think the, the universe of opportunities continues to grow for some of the reasons we mentioned earlier, more entrepreneurs, more, data scientists coming out of, of universities, more, more M&A from corporates looking to improve and acquire additive technologies.
Dan Aylott:
So as the universe continues to expand, I think that there is enough opportunity for more, more firms, more managers, more funds to be raised, but there probably will come an inflection point, right. Where, where potentially there becomes too much money and the overhang becomes too great. The managers either become ill, disciplined, or valuations get so high that it can then impact returns. And that’s always the concern and something that we’re focused on a lot,
Ross Butler:
But we’re not, we’re not close to that point though. Would you say….
Dan Aylott:
I don’t think we are in Europe yet. No, absolutely. I think there’s probably quite a way to go. We still like to see our managers remain disciplined, as it relates to fund size and strategy. But there does seem to be, an increasing opportunity set. And back to that stat, I mentioned earlier about 20 billion raised by European VCs, 40 billion invested, that tells you that even managers outside of Europe are looking at Europe as a potentially fertile place to invest. And I think that will continue and we’re seeing more and more, for example, U S firms setting up offices in Europe that haven’t previously had boots on the ground here. And so I do think there’s a way to go on that.
Ross Butler:
So if I’m a European venture manager or growth manager, it’s a good time to hit the road and start fundraising, but I’ve got to be disciplined. I’ve got to stick to my knitting as they used to say to what degree do I have latitude with regards to kind of think about different fund structures or sub sectors. Do you think there’s, there’s investor appetite to see firms explore those kinds of innovations?
Dan Aylott:
Yes I think so Ross. We are seeing, in terms of funds raised, ‘opportunities’ funds or, or ‘overage’ funds so that they can continue to back the winners in their portfolio. And this has been a phenomenon that we’ve seen for a few years now and that can work really well. Managers want to continue to invest with their best companies and if they can select the winners in their portfolio, then the benefits to their investors are all great. And obviously, investors must be comfortable for the longer hold periods that that entails. But we’ve seen, we’ve seen a lot of that happening in terms of fundraising and that’s one way for managers to expand their offering if you, like.
Dan Aylott:
I think the other side is that increasingly we’ve been seeing specialization across the, across the market and this applies to the buyout space. It applies to growth, and also it applies to venture where we’re seeing managers really sort of focus on what they understand what they know best. And it might be areas of things like FinTech. It might be AI, it might be SAS or consumer. And, and we’re seeing an increasing level of specialization with, with some firms. This can, this can be interesting. It allows LPs and investors to really kind of construct their own portfolios in the way that they want to, if they have a, a belief, for example, that FinTech is where the greatest opportunities are going to be. They can add some FinTech opportunities, maybe some crypto, that’s another area where managers are really specializing. And so we’re seeing an increasing amount of that. Again, we still like to see managers remain disciplined, raise the right amount of capital to prosecute that strategy. And that’s always the key consideration for us, but we’re definitely seeing more of that in the venture space and frankly, elsewhere in private markets. There’ this theory that as, as a market evolves there becomes more specialization and more deeper domain expertise within the managers.
Ross Butler:
And is that a firm or fund or both phenomenon? So, I’m thinking if I’m a generalist venture capital manager, is it the right strategy to start raising very siloed funds,
Dan Aylott:
Different strategies, work for different managers, right? There are definitely, there are definitely examples where people have been successful at doing just that as you described. So, they raise different vehicles within, under the same firm umbrella and have dedicated teams prosecuting on those strategies. They raise a, a one fund, one pool of capital, and they have teams within their firm that specialize in certain areas, but ultimately investors get a diversified portfolio across those, across those themes. And then the other thing is the other way of doing it is to be a single strategy firm with a very clear specialization in what you’re doing, whether that’s crypto, whether it’s digital health or, whatever the sub strategy is. And so there’s different ways to play at Ross. And there will be different ways it will work for different firms. I don’t think there’s a one size fits all answer to that really.
Ross Butler:
Does Europe have any particular sub sector advantage advantages in either of those kind of very broad spaces? I mean, you mentioned a couple already FinTech and
Dan Aylott:
Yeah, it’s interesting. I, and I think these, these sub strategies are still emerging, really Ross. I think we’re watching closely areas like FinTech, and I think the fragmented European sort of financial services markets are helpful to that. And the, the different currencies in, in Europe can be helpful to spawn interesting opportunities across FinTech. So that’s one area. I think Europe is a leader in yeah, environment, environmental issues. And so climate tech could be an area that Europe excels at. And, and there are some, some managers that we’ve seen that are focused on, on those types of strategies, agritech, climate tech energy, that kind of thing. But yes, I think there are certain areas that that Europe has a unique kind of positioning for areas such as, SAS and enterprise of enterprise software, SAS digital health, I think are probably a little more global in their, in their sort of their reach if you like, or applicability. So I think we’re seeing as much innovation there in Europe as perhaps we have in the U S although probably, a few years behind in terms of the development of the market, as we’ve talked about already. So
Ross Butler:
In the UK versus the rest of Europe, because obviously the UK is still in Europe given the events of the last year, rather than put Brexit on the back burner. But, but how are things looking from a vendor perspective there,
Dan Aylott:
That’s a good question because Brexit, like you say, we’ve been talking about Brexit now for, for, for more than four years, right? It’s well, when you’re coming up for five years and I think when then the referendum result happened I talk about this as well in the context of bias, but I think just the uncertainty around Brexit was the key thing. Now that we have some certainty, I think people can adapt and they can, adjust their, their, their business models to deal with, the additional admin that’s related to Brexit. I think the key thing we were concerned about were, was talent and movement of talent. So I think we still got a way to go really Ross before we can answer that. And no one has a crystal ball. I, what I would say is that particularly in the venture space in Europe, there have been, hubs that have, have, have grown up in Europe, places like Berlin cities in central and Eastern Europe in the Nordics, there are the French ecosystem is flourishing for venture.
Dan Aylott:
And so I think, I think venture capital really i, a pan European phenomenon, although, as I mentioned, earlier in terms of venture backed employment predominantly, it still resides within the UK as a, as a percentage of the overall market. But I think perhaps what we’ll see is a more even distribution of that across Europe.
Ross Butler:
Can we talk a little bit about the exit market you’ve already touched on the fact that there’ve been some easing with regards to IPO restrictions, what’s your general view on gone on, on the exit world?
Dan Aylott:
I mean, I, I don’t know if the regular, I haven’t seen the regulations around listing. I think we’re still being debated, but I think it’s been recognized that in Europe there needs to be an easier path to listing companies, venture backed companies. And so that is, that is I think, still under review. I don’t, I haven’t seen the results of that of that review yet. But as I said earlier, I think large corporates have become more acquisitive. So there’s probably more opportunity for M and a, and there’s also the U S market. So European companies can still can still go to the U S for, for their access. I think it’s still something that’s improving. And for example, there’s been some very successful life sciences exits the, they don’t necessarily hit the Heights of some of the U S listings that we’ve seen, but that they are happening and, and producing some very attractive returns for investors. And I think that that will continue to be an improving picture as time goes on and will help again adding to the to the attractiveness of the European market.
Ross Butler:
I guess one of the things that the venture industry has struggled with is, is a lack of natural institutional investors that are venture capital minded. But I assume that that’s something also that will develop and, and grow over time as investors gain experience in the asset class.
Dan Aylott:
I think so Ross, yeah. And it comes down to risk really, and the perception of risk. Right. And we work with clients of all shapes and sizes, right? With all different types of programs. We’ve, we’ve Cambridge, Cambridge associates. We have been advocates for venture for many decades and our clients have done extremely well from their venture allocations. And so, I think, I think overall, we have an easier time of convincing clients of the benefit of venture, but look, it’s a, it’s a re it’s a riskier asset class when you look at the loss ratios, for example, in funds they’re still very high. So that doesn’t mean that, as I’ve said, performance has continued to improve in Europe and has been, for mthe right managers in the U S have been extremely strong.
Dan Aylott:
And the point there is that the winners, far outweigh the losses, right? You, you need to pick funds who can find those breakout deals that are going to produce the returns that investors are looking for. But I think there’s still this perception that venture overall is a riskier part of the market. And so, I do think that as a, as I mentioned earlier, as the returns continue to solidify and be strong more and more investors will take note more and more investors will take a closer look at venture and find us a place for it, an allocation for it in their portfolios. Particularly as the traditional. And, if you look back at the buyout opportunity in Europe, the early two thousands, there was a lot of low hanging fruit, white space returns were very strong. People could generate great returns. Second decade returns have moderated. It’s been harder to differentiate yourself. The market has become more efficient. And I think as those parts of LPs portfolios start to see that there’ll be looking for other ways to generate outsized returns
Ross Butler:
That you also cover private, private equity buy outs, but from a growth perspective. So what, what are you seeing there are there? I mean, it’s easy to call yourself a growth-oriented buyout specialists, but how do you determine that that’s actually the case?
Dan Aylott:
Growth is a strong determinant of returns. And so, when we’re looking at managers, we’re looking at, what type of businesses they’re buying what are the growth rates in those business in terms of, of revenue and, and how are they helping to maintain and even grow that revenue over there, over their whole periods? That’s not to say that we, we don’t look at any managers with a different strategy. But I think increasingly over time, we’ve seen that just, buying, buying companies, applying a bit of leverage, making a few operational changes to increase margins. Doesn’t really, doesn’t really cut it in terms of achieving the sorts of returns that investors would, should, should expect from this asset class. And you really need to have an element of growth. Now that growth can be, it can be a quiet, it can be organic, there’s different ways of, of looking for growth in buyouts. But that’s what we’re focused on. We’re always looking to see where that growth is coming from. And I think, as I said, it’s an important determinant of returns.
Ross Butler:
We’ve also seen buyout firms move into the venture space as well, which I suppose with some buyout firms has a cultural effect, because there was once a very clear division between the VC and buyouts for a long time, and perhaps that’s not so clear anymore.
Dan Aylott:
I’m not sure that’s true. There have been some examples of some buyout firms establishing venture teams. There are some buyout firms that feel that having a venture program or a small venture fund alongside their private equity business is additive because they get to get, they get to see innovation and it’s kind of earliest form and that can inform where they want to look in that buyout strategies. I don’t, I haven’t seen a lot of that actually, Ross there’s some definitely some examples. And I think you’re right. I think the, probably the issue is that it’s a very different skillset, a different mindset. You need dedicated resources for it clearly. And so it’s difficult, it’s difficult to integrate. And a private equity mindset is different from a venture mindset in many ways, private equity is all about preserving capital, not losing any capital.
I mean, venture in venture capital it’s, it’s, it’s almost expected that money will be lost. As I said earlier, loss ratios are still somewhere in the 30 to 40 range. I think it might even be higher. I don’t have the numbers in front of me, but it’s almost expected that a part of your portfolio will fail and, and as entrepreneurs that’s okay. You’ve got to focus on your winners in, in venture. So it’s a very different mindset, and I think it’s hard for a private equity firm to have that sort of similar approach. But no doubt, as you mentioned, there’s been a few firms that are doing it and some doing it successfully,
Ross Butler:
Going back to the sector idea, does that also apply in terms of specialization? Does that also apply to the buyout world in the same way?
Dan Aylott:
Yeah, definitely. And it’s probably a little more advanced, I would say, in, in, in buyouts potentially where we’ve Cambridge associates long been investing in managers that have sector specialisms. So again, predominantly, or I would say the US has been ahead of the head of Europe in that. So, in, in sectors like healthcare and sectors like technology, there’s actually a few opportunities in Europe for those types of, of investments, but we still believe that sector specialization and deep domain expertise, is a positive for, for investors. And we’ve, we’ve got the performance numbers to show that actually the, , if you’re a specialist, you, you outperform your generalist counterparts. And I think in areas, for example, like healthcare in, in Europe, where again a fairly underserved space for specialists, it’s an, it’s a sector that has long been invested in by generalist managers.
But we, as I said, we believe in that sector specialism, and that’s an additional domain expertise such that, managers that have that focus should have an advantage. And so we’re definitely watching that. There’s a, there’s a handful of managers where we’re interested in, in Europe for our clients and looking to invest the capital on their behalf in, in those strategies across the size range, by outsize ranges. Yeah, not so much, actually. So I would say that specialization tends to start in the smallest end of the market. And there’s a number of factors there. So probably related to spin out so often, we’ve seen sector teams or sector heads spin out of generalist firms to set up a dedicated sector fund. Those funds naturally being first-time funds being more focused and more specialized will be smaller.
Now over time, we fully expect some of those, those funds and those managers to grow and expand and, and become larger. But there are very few large specialists in the European market, unlike in the US where we’ve seen the emergence of some very large say technology players and increasingly healthcare specialists, certainly some consumer specialists in the U S that are now multi-billion dollar funds. I think we’ve got some way to go in Europe before we have that level of opportunities at the larger end, but we’re seeing several interesting things at the smaller end of the market where, arguably markets are more efficient. I think they’re more efficient, they’re more reasonably priced from a valuation perspective. And where investors and managers with real domain expertise have an advantage. So I think it’s interesting for the low middle market and the middle market at this point.
Ross Butler:
Dan it’s mid-April, and I understand this is your first day back in the office for the best, best part of a year. How’s it, how’s it going to affect ’em and how has it been affecting kind of day-to-day business where you are?
Dan Aylott:
It feels very strange to be back in the office today. It feels like my first day at work again, but having been on calls like this on zoom for the last year I think we’ve all got quite used to it. So it’s been very interesting to see how managers have dealt with, with this pandemic how they’ve dealt with deal origination sourcing of new transactions, which largely has been done virtually on calls like this and the fundraising process. So, I’ve been involved in a number of DDS over the last year where everything has been done virtually. I have personally find I’m looking forward to being able to get back to meeting managers in their offices. But actually I’m always amazed at how well this industry adapts and, and in particular for this crisis and the specifics around the pandemic, I think the industry has moved incredibly to adapt to this new environment.
It will be interesting to see how things unfold as easing unlocks. I think that the preference for meeting face to face and that sort of real interaction with, with, with managers will still prevail. And I think we’ll have definitely be meeting in person again, hopefully soon. I think the industry is probably more aware of the carbon footprint it has now in terms of travel. So I fully expect, and I know here at Cambridge Associates, we’re definitely thinking that through in terms of what makes, what makes sense and, and going forward in terms of our travel policy. But I think it will, I think it will have to come back in many ways. I had a manager asked me the other day, we’re planning our annual meeting in November.
Ross Butler:
What format would you prefer for AGMs etc? In-Person or virtual?
Dan Aylott:
Actually both. Please! I think investors will want the option. I think going forward they’ll will demand to have different ways of doing things. So it will be very interesting. I it’s been, it’s been really surprising to me how quickly the market rebounded from a fundraising perspective. So, Q1, and I think through the majority of Q2 last year, everyone was focused on their portfolios, trying to understand what COVID meant for their portfolio companies shoring up those portfolios. Making sure that, their companies can survive this period. And then I think beyond Q2 as, as it emerged that certain sectors strategies where we’re going to be fine and resilient through this, I think the fundraising market really came back and, technology, healthcare, all the things that we’ve talked about, very resilient through this.
And I think that will continue. I think that’s an acceleration in innovation if you like that, we’ll just, just continue. So it will be interesting. I think this is going to be a fascinating period for everyone in the industry to see how this unfolds. But I’m expecting to continue to do some of this, some of this sort of virtual meetings and discussions and conversations with managers, with colleagues but I’m also expecting to have some more interaction face-to-face as things ease and as, as, as prospects live writer globally,
Ross Butler:
I do hope so, Dan, and thanks so much for sparing your time and your insights.
Dan Aylott:
Pleasure. I really enjoyed it. Thanks Ross. Appreciate it.
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