Archives: Podcast

Michael Lindauer

Michael Lindauer, Allianz Capital Partners

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Fund Shack
Michael Lindauer, Allianz Capital Partners
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Michael Lindauer is co-CIO of Allianz Capital Partners. He joined the institution in 2003 and has been an influential decision-maker with regards to backing private equity managers, and a respected and informed LP. He is based in Europe and has responsibility for ACP’s global private equity investment programme.

He talks to Ross Butler of Linear B Group about Allianz’s investment business and market-view, approach to GP selection and terms, and much more. This is a must-watch conversation for any private equity manager who wishes to understand how an experienced and thoughtful institutional investor approaches fund investment opportunities.

Jim Strang 2

Jim Strang, private markets – the inside track

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Fund Shack
Jim Strang, private markets - the inside track
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Jim Strang is chairman of HgCapital Trust, a senior adviser to CVC Capital Partners, independent director at the Business Growth Fund, a senior adviser at Bain & Company, an advisory director at Campbell Lutyens, a Fellow at the London Business School, and a senior adviser at Hamilton Lane.

Back by popular demand, this is Jim’s second time on Fund Shack. We talk about the state of private markets and how the industry grows from here.

David Ewing

David Ewing, ECI Partners

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Fund Shack
David Ewing, ECI Partners
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David joined ECI Partners, one of the UK’s oldest buyout funds, in 2001 and is now co-managing partner. He started out in software and has completed several landmark deals, including the UK’s first buyout of a native digital business and the UK’s first buyout of a native SaaS business.

We talk about software investment, the UK’s competitive edge, originating deals in the mid-market, expanding internationally, and the prospect for private equity returns.

Mirja Lehmler-Brown

Mirja Lehmler-Brown, Hayfin

Fund Shack
Fund Shack
Mirja Lehmler-Brown, Hayfin
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Mirja Lehmler-Brown is the founding managing director of Hayfin Capital Management‘s Private Equity Solutions investment team.

She previously worked with Hayfin founder Tim Flynn (listen to his Fund Shack podcast here) at Goldman Sachs, before moving into PE fund investment with Aberdeen Asset Management and Scottish Widows.

Ross Butler (00:00):

You’re listening to Fund Shack. I’m Ross Butler. And today I’m speaking with Mirja Brown, a managing director with Haven capital management. Mirja started out in investment banking with Goldman Sachs and then worked in asset management with Scottish widows and Aberdeen. She joined Hayfin to establish and build its private equity solutions business. We talk about setting up and growing an investment function from the ground up manager selection, direct secondaries, and investment opportunities across Europe. Welcome to fund shack. You joined Hayfin in 2018. I think that’s correct. Tell me, how did you get involved with it

 Mirja Lehmler-Brown (00:38):

Started quite a long time ago, Tim Flinn, our CEO, and founder worked at Goldman Sachs.

Ross Butler (00:45):

Who we’ve had on Fund Shack 

Mirja Lehmer-Brown (00:46):

Yes, and we work together at leverage finance. In fact, we’re sitting next to each other and I left, Goldman Sachs to move, up to Scotland. My husband is Scottish, but we stayed in touch over the years. And so I, heard the story evolve from him leaving and then coming up with the idea to set up, HayFin. And, you know, we exchange ideas and views and, and shared learnings up in Scotland. I started to invest in private equity with Scottish widows initially. And that experience from an LP perspective was also interesting, you know, to Tim when we started out. So when he sat up, he, had discussions with a few different private equity funds and he asked my views on who they were and what potentially could be a good partner for him early doors. So, that then turned into him growing, uh, or him and his team growing the business.

 Mirja Lehmer-Brown (01:47):

And in 2070 that institutional investor changed to British Columbia investment management corporation. And he’d grown the business from lending and other different products within the credit space and never, ever kind of, I guess, before considered the equity, opportunity. And that’s where I then spent over 10 years up in Scotland. And, so he asked me if I would want to, what would I do if I would set up a private equity mid-market business for, British Columbia? How would that look? And would I be willing to do that on his platform? So I did that and come up hopefully with a compelling strategy because British Columbia certainly thought it was a good idea. And that’s why I moved over in 2018 to start from scratch with, with no team, no processes, but a fabulous platform and brand in form of Hayfin.

Ross Butler (02:49):

So that sounds like a great opportunity, but, quite an unusual one, because you had a very large institutional background. So you sat next to Tim and you were doing presumably were doing credits at the time, is that correct?

Mirja Lehmer-Brown (03:00):

Correct? Yes. So Goldman Sachs, but from Scottish widows. So when I started, there was only private equity, only Europe, predominantly mid-market and across the spectrum from funds investing from co-investing and also secondary investing, which is three of the larger group of investing that you can do in the private equity market as an LP investor.

Ross Butler (03:24):

So why did this kind of more entrepreneurial opportunity of setting something up from scratch appeal to you?

Mirja Lehmer-Brown (03:29):

Very good question. I come from the middle of nowhere, in Sweden and I’m actually the first person in my family to go to university. So arrogance and Politics are something that I can say I’m allergic to. And in a large institution, I think when you start out working you’re so focused on delivering a good job that you don’t notice political aspects. I think as you grow older, more experience wiser, you start to figure out that it’s not just about that delivering. It’s not just about the excellent, it’s lots of other things going on as well. And at that point, after 10 years in a consolidating Scottish asset management market, it’s been a number of combinations that we had gone through much larger group and, the firm had become very political and that again is something that’s really frustrating. And I also just in itself, for me, I’m driven by delivering really good investment return based on facts.

Mirja Lehmer-Brown(04:35):

And in that, the energy really needs to go to originate, discuss ideas, pick the best investing. If you need to worry about Politics, how you need to behave or not challenge or challenge. There’s so much energy leakage out of a team or an organization. So that frustrated me and triggered to think, well, if I start from scratch and I can set the culture, I can handpick a team. I can obviously ensure that we have none of that, that we can be a group of individuals with different backgrounds that burn from the same purpose in delivering those returns very often for pensioners, but in a way that then avoid negative aspects such as Politcs.

Ross Butler (05:29):

And so you’re only what three years in that state. I mean, how’s it going from a cultural perspective? Have you been able to, introduce that kind of different culture?

Mirja Lehmer-Brown (05:39):

Yes. It’s, it’s um, it’s going really, really well. I mean, you know, back into the entrepreneurial aspect, it can be scary too, when you haven’t done that before. And you can question yourself whether you’re able to, I mean, from sheer experience, point of view, you build so many networks, you build so much pattern recognition that, that clearly you can take with you, but, but you know, where people come and join you as an individual, is scary. But I think the fact that we talk with so passionately about the fact that it’s team-based and that everybody is equal if you will. And we start, we start with the junior people, sharing their ideas fast up into the senior, and there’s lots of frustration. Now, the private equity industry has grown up and many of these organizations have been quite large.

Mirja Lehmer-Brown (06:33):

That means lots of mid-level and junior, uh, uh, staff. If you’d be, look, people are frustrated with the same thing I was frustrated with. And if you see the people we were looking for, work Lilly, high-ability ambitious people, but then driven by the same values and principles of team, of responsibility of doing the right thing, are working hard clearly, but fact-based. And then also this continuous improvement mindset were also the senior people want to invest in the junior, learning by doing the type of job. You don’t read some books or become a good investor, but genuinely if you have as a mid-level and junior in a person genuinely feel that the senior person sit there for you, side-by-side they roll their sleeves up and want to transfer that knowledge to you. It’s a wonderful proposition. And hence it took a little while because it was not noon, you know, from a brand perspective on the equity side, but windows discussions, clearly lots of people that didn’t fit in.

Mirja Lehmer-Brown (07:42):

But there were a lot of people that were intrigued and were really looking for the same things. So now we’re a team of eight people and again, operating very much under those types of ideas and principles, you know, living, breathing that culture. And hence, that’s the most satisfying we are, did the strategies working and the performance coming through strongly now after three years, which again is interlinked. It helps the culture help the feeling of wanting to come to work. You know, the belonging of being there when it all works. But I think it’s driven very much by the cultural elements of it.

Ross Butler (08:23):

Yeah. Success definitely helps. Did I hear you say tha, junior people speak first?

Mirja Lehmer-Brown (08:29):

Yes. Around our, so our investment processes such, institutional three steps, that’s no different, but when we, um, you know, start in the team, so the first lab level, the one-pager, everybody is expected to readapt to a certain degree and we start with the most junior person. They need to share their views fast. And, everyone comes in many have banking background when they come in more of the mid-level, people when they joined, came from private equity, but none had really had that experience before. So when they joined the team meeting and were discussing ideas, they were not prepared. She was say, first time around the fact that they needed to express their views. First, second time around, they were very prepared. And why we’re doing this is it’s the same thing. As many things you can’t tell to children to avoid mistakes, they need to do it themselves in order to properly learn and invest in.

Mirja Lehmer-Brown (09:32):

There are so many different aspects in the pattern recognition. You know what you need to think about. And we obviously have strong protocols and processes to help along the way, but it’s really your judgment. Your thinking. If you listen to other people, you don’t really learn what is important. If you need to read about the company in a situation and you come up with your views, a unit of thought it through it’s your views. Um, and very often initially they are not filtered or the weightings are not, you know, where it should be, but it doesn’t matter because, for us, it doesn’t matter. It’s the only way to learn. So we look at a lot of things. We originate a lot of things. It’s part of our model, but we do be very, very disciplined. So we do very little, but the more we look at, the more we discuss, the more we learn and the more they learn in, changing, adjusting the way your thinking to become more balanced in their view and also go away from, is this used to good company and just come to a good company. It doesn’t necessarily become a good investment if you pay too much. So it’s just learning around companies is certainly important management teams and pricing and structure and part of value creation. And, and with that, quite quickly you can see the evolution in their thinking, their alignment with the filter, and how we assess where their, a situation is a good investment or not. And that’s also great to see

Ross Butler (11:03):

Tim said to me about, diversity, but from a very broad perspective, um, which is making sure that you’re not hiring in your own mold and making sure that, everyone, not just from the gender or racial perspective, but also in terms of, uh, the way people think and their economic backgrounds and all of that. But it can be in practical terms, it can just be very easy to, to, to instruct a recruitment agency to say, we want people from Harvard and Oxford and, you know, and suddenly you’re already going down that route. To what degree do you feel you’ve achieved some level of let’s call it intellectual diversity around the table so far.

Mirja Lehmer-Brown (11:37):

Yeah. And there are so many layers to it and we are eight people, but we are all different nationalities. And many of us have, not even two, I’m half Swedish, half German, and that’s only part, but, you know, it’s the language, it’s also the culture, the way you have been brought up, which then, the principles and values, because while do want, diversity in thinking for sure, diversity in pattern, you want a different type of pattern that recognition, but you still want the same values. You need to find a group, that, that those principals on why we are here needed to be the same, even if we are value-add from the pattern recognition in analyzing deals

Ross Butler (12:21):

Now in terms of your actual business, maybe could you set up for us, you know, your mandates, what, what you are investing in and where are your sources of funds?

Mirja Lehmer-Brown (12:30):

Yes. So we are, continue we’re backed by our Canadian as a British Columbia investment management corporation. And the strategy is the European mid-market. One of the things when I analyzed, uh, you know, setting up in 2018, because it was different when Haven was founded, they were very early into a new growing market that, the market of direct lending, private equities, quite mature. So one of the things that we did, I feel that the, in my view, the private equity industry has created silos very often. There’s a separate, product for primary funds or a second, separate silo bucket for co-investment or a sec, you know, secondaries have a different bucket. And I felt that for us doing mid-market, we don’t want any restraints. We want to be able to originate across the board and just focus on picking the right that the best opportunity is flexible across your mid-market.

Mirja Lehmer-Brown (13:30):

The larger funds, larger companies to a degree, you can say, I guess it’s less risk. So it’s a different style of investing and different returns, mid-market, or to generate, a premium return in comparison to the larger market. But if you look in the dig into the track record, people have all failed in doing that. And it’s been too much volatility. So when we set up, but we want to do, if we have one bucket allows us to, one year, maybe they’ll be more opportunities in, in co-investor as of late, this GP led, uh, secondary, a single secondary, which we do in Medan, several of them, but it’ll go, you know, one year or another year, it’s slightly different. If you only could do one type of investing, it’s very hard. And also very often the solutions we do, the fact that the same team can do a combination of investing that otherwise might fall in between the buckets is very powerful.

Ross Butler (14:31):

So in larger competitors, would there be a separate team for co-investment, or all your guys, do everything?

Mirja Lehmer-Brown (14:38):

All the guys, do everything to avoid things, falling off the cracks and allow for, for more opportunities and more discipline in what we do. And that’s been really helpful. And it’s already evolving, we’re now on our second program, and it’s gone from slightly more funds than you start out, also generate some of the co-invest opportunities to now coming out of the COVID where, this GP led market on the concentrated end, which has been around for a long time, but it’s really exploding. And that suits our skillset because we have built a team of stock pickers, very well. And we don’t, again, because we haven’t got a bucket. We don’t mind, it’s an asset opportunity. We don’t mind if you call it a secondary or a co-invest in what we do. And, also we find that the relationship, uh, from the primary side because the core thing with the GP led is also understanding why, why do they want to do this? And it’s the right thing for them and the acid, which if you have followed funds for 10 plus years, and they know the individuals in these funds, you will have a much stronger view on whether it’s the right thing to do. Not just numerically, but because we focus on both. So you gain that experience from primary funds investing is very helpful across the board. But particularly I would have said in the GPLS single secondary situation

Ross Butler (16:13):

When you’re setting up a new business like this, I guess the challenge is that you don’t have any existing relationships because the best managers will have long-standing relationships, although you were in the market yourself before.

Mirja lehmer-Brown (16:29):

Same thing, the principle of Hayfin, working with very experienced people. So, we hired Gonsalo Aras who co-led this, the private equity solutions team with me are very experienced from different some overlapping, but predominantly, uh, different parts of Europe and different types of relationships. So we bring that eminent relationship that you have as an individual is personal, it’s partially linked to the brand. It’s got its widows where you stand for, but moreover, when you’ve gone for, for, you know, over 10 years and, and quarterly knocked on the door on people to have a coffee, the Swedish way to have a coffee, that’s how you build trust that you take with you, because in the end now, in particular, there is so much capital the capital in it says, doesn’t matter. People want to choose an individual relationship that they feel they can work well.

Mirja lehmer-Brown (17:32):

It needs to be a high-quality type of capital, the quality of capital matters, but its excess. And then you go down to a more personal element. Is this an individual? I feel I can trust, is this, we can have a dialogue with somebody that is constructive and helpful to us. And that’s in the end to me why people choose, to work with somebody in a fundraise or in a co-investor opportunity or in this teepee lads, they’re really attractive opportunities. GPs have a choice. And the choice very often in who they select is just part capital and a lot about who you are and what you stand for and what type of relationship that you built.

Ross Butler (18:18):

Yeah, it’s a people business because you’re committing, you’re not just investing.

Mirja lehmer-Brown (18:24):

And I do think the nice thing, the additional benefit from setting up the entrepreneurial side, which originally I didn’t think of. So originally we’re more of the strategy being differentiated, the culture, being different shaded, and also the discipline. And I guess the credit focus from Hayfin to avoid the volatility in the mid-market. But the additional benefit is we are not entrepreneurs. The whole team, we call, is the founder team, every single one of my team, we are together. We are, the founders are our track record together. And we built this from scratch that also when we sit down very often, the mid-market, they’re also founders of their funds. So we can discuss the challenges of hiring people, motivating people, motivating the younger generation with certainly different to kind of the older generation systems, how that work or I see, but it becomes a different type it’s equal partner to partner. And we’ve gone through the trenches in a similar way, which also add to that, you know, the strength of that relationship.

Ross Butler (19:35):

Can I ask, what proportion are you roughly, in terms of, direct fund payments versus the more tactical approaches, co-investment and secondary and so on, and where, where would you like to be?

Mirja Lehmer-Brown (19:48):

You know, the core initially is the flexibility and the first program. So the first investment program was more than 55% funds and, you know, 45% asset opportunity because we don’t really split whether it’s co-invest or a GP-led opportunity. Out of COVID came an additional need for asset capital. It was too much, co-invest capital, but not always co-invest capital in the professional form. And, you know, out of it came, people want to work with a professional partner, a partner from the co-invest, not just in this indication, a partner that can be fast and have their own view, their own view of the asset that underwrite the asset themselves. They, you know, through COVID there were issues in co-invest and some, LP co-investors were worried about the performance and that created some friction in the relationship, the GP and LP so that, you know, the evolution of that was that the GP was happy or to work with somebody who did their own work.

Mirja lehmer-Brown (21:05):

So, you know, if we pick wrong, it’s not the GP’s fault, it’s our team’s fault that this, we would never blame a GP for offering us an opportunity. It’s our own process. And we would, you know, I don’t like blaming, but we will make mistakes, but we will be in ourselves. So that I think has been very, positive. So we’ve actually seen way more co-invest opportunities than I thought beyond the fund investments that we do. And then as I indicated, this deeply led market, this is full exploding. So the new program that we’ve started, or the second program we start,

Ross Butler (21:40):

Can I just ask you a question about, co-invest first, and then you can tell me about GP.

Mirja Lehmer-Brown (21:46):

I’m just going to say, so the proportion is 70%. So now 70% asset opportunities and 30% funds

Ross Butler (21:51):

I’m sorry, you still answering my question. 

Mirja Lehmer-Brown (21:54):

I was trying to 

Ross Butler (21:57):

It’s a different skill set, isn’t it? Assessing single asset opportunity versus, and so you’ve got a team of eight and they’re already looking at fund investment co-investments and these tactics, and, but they’re also looking at, company’s specific opportunities.

Mirja Lehmer-Brown (22:12):

So the co-invest, that’s why in the secondary market, it’s been a lot of this LP stake. So when an LP center sells to another LP, we don’t focus on that. That’s very different. It’s broad, diversified portfolios, it’s more cashflow pricing. So that’s not, it’s a very good market to be, but it’s not what we do, but where we have married every single one that we have hired, our focus on developing skills, in picking an asset, which is also aligned with, HayFinn is just from a credit perspective versus the equity perspective. In addition, my view has always been that if you are a good fund investor, that will help you as well to understand because when we select an asset, it’s not used to kind of do the numbers on whether that is a good investment. We very often need to understand why is that GP the best owner of that assets?

Mirja Lehmer-Brown (23:11):

Why would they be the good part of helping the value creation in that business? And that are more aspects that you focus on from a fund investment perspective. So certainly, you know, it’s certainly super value add even if the core skill to a degree is the fact that peeling the onion on the investment on an asset investment opportunity. That’s why, if you now go and look at very often the large secondary funds, they have predominantly priced cashflows because the market on the LP stakes side was so much bigger. They need to carefully think if they now, recycle their individuals to look at this more focused opportunities on the secondary side. One very often risk-return spectrum, very different from this portfolio, diversified cash flows. And as you rightly said, the skill set needed to do that is also very different.

Ross Butler (24:16):

So kind of from a philosophical perspective, your team feels almost more aligned with the GP mentality than perhaps the traditional institutional LP mentality. Would that be fair?

Mirja lehmer-Brown (24:28):

I think that’s a very good observation because we work very much like a GP. We source a lot of situations and we are very disciplined around the picking, and think much more like an act in that sense, much more like a GP.

Ross Butler (24:48):

What is it that attracts you? What would you look out for?

Mirja Lehmer-Brown (24:51):

That’s a very interesting question and actually linked, uh, the mid-market and pitfalls of the mid-market. Because if you look at the larger funds, CVC, or admin, it doesn’t tend to be people-dominated anymore. They have very strong processes. They have sector teams, they’ve got lots of operators around, they still need to be mindful about culture and how they drive organizations, but it’s a different type of diligence. In the mid-market, it’s much more, person and culture-dependent. When I started in 2006, the, um, the way people did fund investing back, that was much more numerical. You went through a track record and then, you know, from that track record, you looked at the processes and the track record. And I thought, oh, this must be good people in the future as well. And then I said, but how can that be?

Mirja Lehmer-Brown (25:47):

Because that investment will never come back. So the motivation of, and the process of choosing it and the skill set in the people align, those are the more important elements to review in order to access future performance. So in my own learning, coming from the sell side, it took some work, but I really felt that that lots of people went about it the wrong way, just focusing on numbers. So from that came a completely different type of filter, a hundred-point scoring system that, in addition to strategy and, processes and track record very much focused on the culture. Leadership, what are the motivators? Why are these people doing this. Organization? And the room in the ration linked to organization. Decision-making, functional team, dysfunctional, and those elements are much harder to assess, and to figure out, you need to look for them and you need to build that pattern recognition to see what works, what doesn’t work.

Mirja Lehmer-Brown (27:08):

We are very focused on team-based. Very team-oriented, team-based decision-making teams, where also remuneration tends to be diversified if you will, rather than very strong founder-led businesses, because we think it is, reducing risk as one element. And the fact that back to what we said, that you haven’t got the dominating individual that shut challenge out, it could temporarily look good, but again, that’s a risk from our point of view. And very often when we go in meetings, the questioning is very much. So why are you here? What motivates you over and over again, with every person in the team to get the sense for what they’re saying, what they’re not saying, and, the general, yeah. To try to assess that culture again, because that we have found is a core KPI in assessing future performance.

Mirja lehmer-Brown (28:15):

You need to have local reference points, not their reference points. Very often, I say, that’s why it’s so fundamental to us to be local. Well, I’ll figure out I’ve gone to school with you. Uh, you know, in that referencing is there is a joined connection. We’ll have worked together. We will have gone to the same school, I’ll know someone that knows someone that will know your neighbor in order to that picture, that you tend to portray of you and your team, whether we feel that that’s transparent and true. So we do that first-time funds, which we do. We tend to do 50 reference calls, most of them off a list, and that you can only do if you have long-standing relationships on the ground that trust. And we’ll tell you because they know that your integrity is integral to who you are.

Mirja lehmer-Brown (29:11):

They will tell you how it is, and that is impossible to recreate if you’re far away and impossible to recreate in the mid-market because the regions are so different. Yes. So the portfolio is doing, doing well. Is it really well? Yes. And I think the third thing with this and discuss starting in 2018, setting it up, I thought we would have had a recession since 2016. So I was a bit afraid of 2018 as a starting point in setting up a new program. And so the third part of how we were doing it was to focus on a really resilient, resilient sector and resilient business model. And that was predominantly the timing, the 2018, and that belief in, within the investment period, there will be a correction. And from that, and LinkedIn to in Europe, you haven’t got as many sector funds as in comparison to the US but we believe in sector funds in that, again, it’s the pattern recognition.

Mirja Lehmer-Brown (30:15):

If you spend way more time in one sector, you can reuse your learnings much faster. And with that, the portfolio with them put into the ground in the first program is 70% healthcare and technology combined. And the rest is resilient service model. So clearly we had no idea about the health crisis, but we’re preparing for a correction. So with that sector waiting not only is our performance, the operational performance of the businesses doing exceptionally well, however, from being a high priced environment, the investment that we’ve done has rerated because now everybody wants to do healthcare and technology and resilient sustainable business model. So we have been fortunate not only to have an operationally well-performing portfolio but something that is also been rerated from a relations perspective.

Ross Butler (31:20):

Fantastic.

Mirja Lehmer-Brown (31:21):

And a bit of luck is not bad.

Ross Butler (31:24):

What are the circumstances that you think are legitimate and would attract you to a GP led and what would turn you off?

Mirja Lehmer-Brown (31:32):

It’s evolved initially the, GP leads were for assets. Maybe they hadn’t gone that well and maybe needed a little bit. They still, so the GP believed in that asset, in the value creation of it, but it had taken longer. So that was a position, I mean, necessarily not a weakness, but it wasn’t a strength. And that has evolved what people now are focusing are really trophy assets, assets that are significant winners and with the pricing environment and additional competition, that are now out there, it’s really hard to find really good businesses. So if you have built a great relationship or maybe even changed and put them place a phenomenal management team in a very resilient business, but the underlying structure of a private equity fund is such that after a period of time, you need to liquidate it, you can argue. So why would I sell this to a larger fund for them to create more value?

Mirja Lehmer-Brown (32:41):

When I got hold of this company helped build this to better business, and my LPs can continue to be the beneficiaries of this good returned. So we think creativity is positive. It’s giving GPs more optionality in a market where it’s hard to find those assets. It’s not like every asset in a fund is of that exceptional quality that we are looking for, so that you de-risk it, from buying him to the next three to five years, you know, making a new plan and, and a feeling that this is a good thing to keep that business. I guess it’s linked to, if you look at the public markets, I don’t know the exact statistics, but a significant percentage of the increased market value or the value creation is actually linked to a very small group of companies. So again, the significant winners tend to be the one that continues to drive premium value creation. And those are the ones people tend to want to want to get hold on to. And with that, it needs to be high-quality process clearly, cause there can be conflict in that decision, but it also needs to be alignment. So you can’t just do it because you want to increase a UM you need to also align yourself also with your own, the GP capital, and behave as a buyer and a seller in that situation.

Ross Butler (34:21):

And do you normally, have to partner with other providers, or do you do the GP secondary on a solitary basis?

Mirja lehmer-Brown (34:28):

So depending on size, we tend to invest 20 to 15 million in an investment, either be the fund or a situation. So we have had a number of situations from these discussions going out, speaking to the GP community where we have been in a bilateral discussion to two LPs, if you will, into a situation. Cause we don’t want to be midority. We are minority investors if you will. An LP minority investors to then the largest situations where it’s more a larger group, you know, from five to 10 different investors into that asset.

Ross Butler (35:13):

And you said you’re seeing quite a few of these opportunities out there probably because things are becoming so polarized.

Mirja Lehmer-Brown (35:20):

Yes, it continued to go, we say, you know, let’s see right now it’s math, it’s the fastest-growing part of the second dairy market. No question. And there are a number of opportunities. So I think this will go on certainly for the next two to three years, but there’s always something else that happened. It could be one or two of them that maybe don’t perform that well, but you can also see a lot of people are hiring. A lot of different companies are hiring to address the growth in this market. So whilst it’s certainly going to grow for the next few years, I do believe some people are certainly banking on it growing for a long period of time ahead, but we don’t need it because we have other opportunities to, to invest in as far.

Ross Butler  (36:13):

In terms of how your team, your business, as it was sits within Hayfin, sits within the culture, but also the strategy and any kind of cross-fertilization of ideas and opportunities. How does that work?

Mirja lehmer-Brown  (36:29):

You know, initially again, more experienced people, more pattern recognition, and in different fields, that can be a value add. So just the fact that we know, GPs, where also from the credit side, they might lend into businesses is intelligence people, intelligence networks are always helpful, different angles based on different experiences. And that’s been very easy. It’s very easy because it’s easy to, to me, you need to be careful about some of the walls. So it’s, you don’t share detailed information, but quality of people or whether they got experienced or not in that type of field is something from the PE side that can be helpful. We came with much more of ESG processes because it started earlier on the equity side in Europe than on the credit side. So we work very closely together. You know, the PE team has been able to do ESG profiles of when the credit side work with P houses, we are involved from an ESG perspective from a profiling point of view, rather than they do the deal clearly kind of ESD analysis themselves.

Mirja lehmer-Brown (37:49):

So it’s very beneficial what we’ve now started to do. And that’s even more exciting, is we can make investments together back into what we’ve said instead of staying in silos. We have now two recent deals where we work together with the special opportunities side in creating a capital solutions for AGP into an investment where there’s a peak element and an equity element. And they are not that many of our competitors that actually can stitch together tailored solutions across credit and equity for a situation which, we are about to do our second now and I just expect that to continue. So that then start to, you know, even deeper working together across the teams and then the practice based on this team-based, culture in that, we are, we are super happy if we can work together and create solutions.

Ross Butler  (38:53):

So it’s an equity co-invest with a credit element attached to it, all from the same provider. And how does your decision-making process in terms of governance work and how does it align with the rest of Hayfin?

Mirja Lehmer-Brown (39:08):

So we have our own investment committee. So, you know, the private equity investment committee contains about the senior members of our team and senior members of Hayfin and the special opportunities have a different investment committee clearly. There are some joint members and the learnings from one will apply to the other, but it’s also the focus. Again, the credit focus is different. The type of analysis is somewhat different, different from depending on what angle you come from. Yeah. And, something that was super beneficial was coming into this, COVID, working together was actually, we have a tremendous high yield and syndicated loans team, which are operating in the liquid markets. And with that, a higher degree of macro focus, that goes into their analysis. So coming into COVID, nobody, we’ve experienced the financial crisis, but not this a health crisis members, senior members from the whole firm working together, trying to figure out what is this, is it temporarily or is it something that we’re going to go into. A lot of people are going to die for a long time and it’s going to be a very different type of situation. So Gina Germano and her team had lots of phenomenon analysis that was very helpful in creating scenarios, right?

Mirja lehmer-Brown (40:44):

Where do we think we’re going scenario setting that was helpful for all of us. And as a group, as a house, we then come up with a scenario that we used as a base case and, every week or so we were assessing, is these the data points that are coming? Is this a valid scenario? And I think that allowed us also in 2020, where a lot of people, at least up until after the summer did not deploy that much. We were able guided by facts and scenarios and analysis working together. Our conclusion was that we can deploy. And we had a record year in 2020, across the board deploying in our different, product areas based on his intelligence and views of working together.

Ross Butler (41:36):

Did the private equity industry is a little bit slow at deploying during, during 2020, but, I mean, it’s a very difficult time because the economic situation has never looked more uncertain. I personally, I think, it still looks incredibly uncertain, and most private equity firms don’t have a chief economist. They don’t tend to even worry about the macro view in my experience so much, they take a view on people, but in a situation of radical uncertainty, perhaps they might need to take more of a view. I mean, I’d be, I’m sure it’s all trade secrets, but I’d be fascinated to know in general terms, what your outlook is with regards to the economic prospects of Europe.

Mirja Lehmer-Brown (42:18):

And I think you’re absolutely right. I think there are all sorts of elements that go into kind of the analysis of what you do. And I do think some of the larger houses definitely apply and have asset allocators based on more the macro, the research macro judgment helping in selecting the underlying businesses. And, you know, we are with that, you know, low growth, uh, for sure in general is something that we think will be here. We had the health crisis currently the aftermath of that is energy issues, supply chain issues, and still too much liquidity into the system. So whilst, you know, over the next little while is, seems like it’s still catch-up effects in a positive sense that are trending. There are certainly clouds out there that could lead them to volatility.

Mirja Lehmer-Brown (43:18):

So I think volatility, in general, is here to say, that’s why with the math typically trying to focus on thematic sectors, which have then growth. So megatrends that, that provide tailwinds. And that’s also LinkedIn. So initially when we said we’re focusing on healthcare and technology, it was more around the fact that we liked that pattern recognition. We liked the defensibility of it in preparation for a correction, but as we evolve and the content constantly need to reassess what we do, we’ve come to think because of the volatility and because in general, lower growth in Europe, if we focus on an aging population, if we focus on digitalization, those are longer-lasting trends that are structural, and we’ll continue to see growth, even if lot of other areas will temporarily go down in a volatility in order downwards adjusted scenario.

Ross Butler (44:24):

In terms of your, your own, section within Hayfin, what does the future hold in terms of growth? And do you have a growth strategy? Is it to just gradually increase your number of relationships or would you consider introducing, I’m not sure of the exact term for it, but the new sources of funds or even grow by acquisition of competitors.

Mirja Lehmer-Brown (44:47):

So, I think we were all growth-minded. So in order to continue to evolve, there needs to be some growth. And with that, we’re having a number of conversations with other similar parties, similar to BCI. So we will grow somewhat by adding, a more diversified investor base, but still though, and that’s very similar, across, Hayfin we do believe in being disciplined, you need to grow. That’s a positive for any organization also for the younger generation coming through. You need to show growth, but not for the sake of it. So disciplined growth. We still believe in ensuring that the right balance in how much you wanted the blot and that’s what’s leading us to the amount of capital we’ll take on. The strategy it’s scalable, particularly on a GP led or some of the co-invest we could have, instead of doing the 20 to 50 million, we could easily have invested a hundred million in several of those situations and the same goal with the fund, but not necessarily 500 million. So ask the market evolves, we will evolve with it, but we will stay on the discipline side because the discipline is also the guiding light that will allow us to act before.

Ross Butler (46:25):

Great. Well, the very best of luck with it, Mirja, it’s been really nice hearing about your startup story, I guess.

Mirja Lehmer-Brown (46:32):

Thank you very much for having me, my pleasure.

Ross Butler (46:36):

You’ve been listening to the Fund Shack podcast, make sure you subscribe and visit our website at fund-shack.com for many more video interviews. It’s the private capital channel for alternative investment professionals. Thanks for listening.

#30 Tariq Fancy, a sceptical sustainable investor

Fund Shack
Fund Shack
#30 Tariq Fancy, a sceptical sustainable investor
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In 2019, Tariq Fancy quit as BlackRock’s most senior sustainability investor. 

In 2021, he released an in-depth three-part essay explaining his disillusionment with the concept of stakeholder capitalism and the ESG investment industry that has grown up alongside it. 

In this private chat, he explains why sustainable investment is ineffective and what the alternatives could be.

We also discuss his work with Rumie, a charity he founded to expand access to education across North America and which is currently very busy in Afghanistan addressing the plight of particularly girls and women in the aftermath of 2021’s military withdrawal.

You can also watch the video version of the interview here.

If you are interested in this topic, also check out our other conversations, with Cyril Demaria on ESG, Simon Witney on ESG and private equity governance, and this debate between the world’s leading economists and philosophers, on CSR and ethics.

Incorect form of transcript\ some inaudible parts

Ross Butler :

You’re listening to Fund Shack. I’m Ross Butler and today I’m talking with Tariq Fancy. Until 2019 Tariq was chief investment officer for Black Rocks, sustainable investments. Earlier this year, he revealed the reason for his departure was a disillusionment with the impact of sustainable finance. He now runs north America based on line education, charity Rumie, which is very active at the moment in helping girls and women, the situation in Afghanistan. Tariq it’s great. Speaking with you. I’ve been really looking forward to this conversation. I wonder for people that don’t know, if you could just give us a brief bio of, of your experience in the investment world and, and elsewhere.

Tariq Fancy :

That’s so great to be here and quick note on my background, I started out as an investment banker for a few years covering the tech sector in Silicon valley actually then spent a long career as an investor mainly based out New York, doing a lot of distress and special situations, investing in a private equity firm later built strategies and did a few other things. And then in 2013 left to create Rumie, which is a 5 0 1 [inaudible] three or charity that uses digital visual technology to, to advance access, to learning for some of the world’s poorest communities. And then came back to the finance industry in 2018, in 2019, where in some sense I was convert sort of merging to two of, of investing in financial bottom lines and then social bottom lines in a sense, or at least trying to as Black Rocks chief investment chief investment officer for sustainable investing. And since late end of 2019, I’ve been turned my focus back to running Rumie.

Ross Butler :

Okay. That’s love lovely snappy bio. Can I ask you, why did you leave the lucrative world of private equity in the first instance to go and run a charity?

Tariq Fancy :

Honestly, it was a personal decision. It was after the passing of my business school roommate and, and very close friend. And he, and I sort of shared this passion for someday doing something, you know, taking our skills that we learned in finance and doing something that we thought, you know, we really cared about and was making a, a bigger difference in the world. And he, he contracted stage four cancer. And so at some point it was, he wasn’t, he couldn’t kick keep kicking the can down the road. And so while he was fighting stage for melanoma, he actually created an education charity in Kenya which is where my parents grew up, my family immigrated from Kenya. And that sort of inspired me then to take the idea I had for Rumi and just go for it

Ross Butler :

Fantastic. And did you find your pre finance experience useful in setting that charity up and how’s, how’s it going?

Tariq Fancy :

So it was useful actually very useful in the sense that you know, there’s a lot of things I didn’t know, around education, international development and so on, but I did know technology well, and I think that the finance background actually helped me understand you know, really how to build something in a careful way and be kind of ruthless about execution. So and it has been going well, we’re doing work right now for digital learning for girls and women and have Afghanistan that we started in 2017 actually. And that is extremely important right now, given the situation on the ground and the sudden restrictions on access for girls to learn there. Given that 80% of Afghans have access to a mobile phone, which wasn’t the case 20 years ago, when the Taliban were last in charge, it does provide sort of a connection to allow them to continue learning.

Ross Butler :

So you’ve had to pivot quite quick, given what’s happened over, over the summer, how have things changed? Are you, are you managing to reach people?

Tariq Fancy :

We are, we are in managing to reach them largely because through a mobile phone you can learn safely from anywhere. And we’re working with a mobile operator in the country. And so there’s sort of an infrastructure is built to reach people safely at any time and anywhere that simply didn’t exist 20 years ago. And so the, the power of mobile technology when that infrastructure is built out is extraordinary. And, you know, in most places in the world, you know, Facebook and, and other applications are aggressively growing and our goal is that people should be, you know, using availing themselves of free learning at the same time using that technology and all the work we’re doing is in local languages in D and PTO [INAUDIBLE], and has seen extraordinary uptake on the ground, just given the needs  it’s working really well. So the goal right now is to quickly expand the content and subject areas and the distribution. So we can meet the needs of 70, 30, 8 million AF cans whose labs have been turned upside down. And in particular, the women who will bear the brunt of it. So

Ross Butler :

How do you, do you finance it? How can I make a donation? Where, where do we go?

Tariq Fancy :

So you’d go to about.Rumie.org. Rumie is R U M I E. And if you go to about.Rumie.org, it talks about some of what we do. We’ll be adding a lot more information on Afghanistan, specifically in the next few weeks as we grow this in response to the crisis. But if you go to the site about.Rumie.org, it gives a, a lot more information on what we do and, and how we’ve been doing it for a number of years now.

Ross Butler :

Great. Well, well, the best of luck with that, that sounds like a, a really wonderful initiative. I suppose, the reason that I came across you though, was when you took a break from the charity, if you can call it that, and you joined BlackRock, as it’s, as you say, as it’s CIO of its sustainable investing business, and you left there in mid 2019 because, and my understanding is you didn’t necessarily agree that sustainable investment as a concept was necessarily doing what it says on the tin. And I’m interested in that I’m interested to know to what extent does it not do what it promises? Is it kind of, is it ineffective? Is it counterproductive or is it not as effective as you hoped? And, and why?

Tariq Fancy :

I came to the conclusion after 14 or 15 months there, that it was ineffective and it, you know, it was in a sense harmless because it wasn’t doing much good, but certainly not what people thought it was, but it wasn’t harmful. The conclusion that it’s harmful is something that I reached after leaving and recently went public to make the argument around. And the idea being that if you have something that people believe is creating impact, and it’s based on a set of notions that I would argue are sort of based almost on fantasy, a convenient fantasy that we can sort of win, sort of, you know, make lots of money investing and fight climate change at the same time. If it doesn’t work. What I realized was I knew that when I had left, because I had the vantage point of being a trained investor, who looked at integrating environmental and social considerations you know, ESG broadly, but [INAUDIBLE] in particular is where people are focused across the largest pool of assets available in the world and in capitalism state.

Tariq Fancy :

And so I realized that if, if I knew that it wasn’t having any effect, but the rest of the world didn’t know that then there’s an argument to be made that it actually actively delaying us because the fantasy might take a few years to work itself out. And so, while I was away, I worked on a study with a university, and we actually found that the more you feed people, ideas around, you know, stakeholder capitalism is the answer to reference the business roundtables argument on, you know, how we improve social outcomes that, you know, ESG is, is good for investing that wall. Street’s focus on climate risks, a whole bunch of things that in practice I found had no real impact. The more that they believe it, and the more that they then people who see headlines like that and hear that information are then less likely to argue that we need government regulation to address these problems. For example, of carbon tax. And those are exactly the performs that all of the experts in society, including no prize economists have been telling us we need for decades. And that really is where I think sustainable investing now is turned the corner and is actually potentially harmful. And that it’s wasting valuable time

Ross Butler :

By some measures about a fifth of all the assets under management are managed in some respect with reference to ESG principles. And so if what you’re saying is correct, then what we are looking at is a colosal, could you call it misallocation of resources, or at least in that allocation of resources that aren’t being allocated in the way that most people think they are, this isn’t a small thing. This is a, this is a huge thing.

Tariq Fancy :

I would agree. It’s an absolutely huge thing, because in many ways I I’d say that this there, I wouldn’t throw ESG out entirely because I think a lot of people will say, well, how, first of all, they’ll be surprised at the fact that ESG could be harmful to environmental and social considerations, given that the whole idea of why we’re in theory doing it is largely that it’s supposed to be beneficial. So that’s one bit that’ll surprise people, but I, I would, I would say that it’s not so much everything in ESG is useless and needs to be thrown out. It’s that you have, I think tools, standards, data, and people, frankly, human capital that have come around ESG that are all helpful. Unfortunately they’re being combined into narratives and products that are harmful. And I say those type of there’s narratives around it that I think are very dangerous and mislead the public.

Tariq Fancy :

And there are a set of products that are being built off those narratives that generally implied that they’re creating real world impact that they don’t create. And there’s no reason to believe that they do create, and that is also very harmful because on one level it’s obviously you would argue it’s unethical to sell someone a product. If they believe it’s doing something in the world, that it isn’t doing just as an attempt to sort of get higher fees out of it. Which I think is quite widespread across the industry. And I think secondly, you know, if the narratives around it are based around the idea that you can buy an ESG product and make money and fight climate change at the same time, what we really need to do is step back and look at what we’re actually saying the mechanism for change, to which buying an ESG fund or doing ESG integration or any of these things create real world social value is based on an idea that the markets will self correct.

Tariq Fancy :

I mean, that, that is ultimately at the end of the day, what it is. I found that out because I spent enough time trying to understand how to articulate. Just not, not just how it’s good for investing, which was, it took a bunch of time to figure out because frankly, a lot of it was being said in the space was quite, it wasn’t greenwash, but it’s what someone else I know called green wishing, right? It was so unlikely and hopeful that it was, you know, borderline greenwash. But I think at some, at some point, you know, these narratives, they’re all based on the free market, correct themselves, they don’t work in practice. I can talk in detail for the, about the fact that I think that there are solutions we can implement, but the ones that are being done in the industry are [INAUDIBLE].

Tariq Fancy :

And so what you end up seeing is that there’s great. There’s great. Hope around ESG is gonna do something right. And every year you see more and more talk about your ESG, right? It’s incessant, everyone claims to be doing it thinks it’s the big thing. You have this growth and ESG assets, right? So you can almost graph them what I call sort of sustainable bubble and all the words are increasing. They’re increasing alongside ESG assets. And then finally enough they’re, those are both increasing on a graph alongside carbon emissions and inequality and all the things that they’re arguably meant to do something about. And the reality is, is because, you know, when you dig underneath these narratives and you dig underneath the, what the products are, they don’t seem to have much of an effect at all. I mean, for the most part, there’s a fraction of fraction of cases where some of the there’s a kernel of truth, but for the most part, it’s mainly marketing.

Tariq Fancy :

And that’s really where the, the, a concern comes in for me. And to give you analogy of used places when I first left BlackRock you know, I left, I transitioned out over six months and did on good terms and I still don’t, you know, I talk to folks at BlackRock and I’ll tell you, I don’t think it’s a BlackRock specific a problem. I think it’s an industry problem. Although BlackRock is of course the biggest player and has been a, you know, at senior management has been a big voice around it. But I, I think that, you know, what I thought of that when I was leaving was that it was like giving wheat grass[INAUDIBLE] to a cancer patient. You know, the, the cancer is I would argue not just climate change, which is slowly spreading, but also I would say inequality and other social issues that undermine not the planet, but our political systems.

Tariq Fancy :

And so it was like giving wheat grass to cancer patient goes very well marketed. It looks and sounds nice it’s green, but of course, you know, there’s no reason to believe it’s gonna stop the spread of cancer, nor any experts who have told us that that would be the case. So should be the case. And I think where I landed after, and, and why I went public this year about it was that I started to realize that it was almost undeniable in my mind that the rest of the world didn’t know the extent to which most of this is just marketing. I would argue marketing intended or certainly designed whether, you know, intentionally and cynical or not to preserve the status quo. And what that means is that it’s not just giving Wera[INAUDIBLE] to a cancer patient, the, the data and the study that I had done with this Canadian university showed that it was actually misleading the public. And it was like giving the giving cancer to, you know, Wera to a cancer patient. And then realizing very definitively that that cancer patient is be, is now delaying chemotherapy because of the sort of frankly false promises. And that, and that, that is, I think the biggest concern that I would have is that it it’s now becoming counterproductive.

Ross Butler :

Yeah. I think if you conclude that it’s not doing any good, I think you have to then conclude that it’s doing harm because we’ve only got so much attention and we’ve only got so many resources. There’s only so things we can do. And if we we’re doing something that’s not helping, then it’s, it’s part of the problem. It’s not part of the solution. So I can, I can see how you got there, I suppose, in terms of moving forward, I quite like to understand why, why the problem is persisting and why people are continuing to promote the, the concept. Now maybe there’s cynicism there. But, but maybe they’re just mistaken. I mean, the investment industry is full of smart people and your, your criticism of it and your, and your series of essays on medium. They’re very good. But not, not particularly difficult to understand. So why aren’t people getting it? Why aren’t people becoming a little bit more skeptical and thinking, well, maybe this isn’t working,

Tariq Fancy :

You’re asking the right question. I think that is starting to happen now. There’s no question that based on certainly the inbound and the response I’ve gotten, that I’ve sparked a debate, which, which was my goal. I think that there’s a debate that we desperately need to have sooner than later that’s in the public interest. And I don’t want a debate that has a bunch of people saying capitalism is crap and throwing stones at it. And you know, which, which is important to understand the majority of millennials do not believe in capitalism, right? There’s studies around this. I would argue it’s because the version of cap. First of all, I don’t share the baby boomer perspective. I sit in between those two generations from a age perspective, I wouldn’t that the baby boomer generation is correct in blaming millennials and saying, oh, they don’t just get it.

Tariq Fancy :

Which is the sort of version I’ve heard a lot. I would turn around and point the figure right back at them and say, no, listen, the reason that they don’t believe in capitalism is because they’re, they’re seeing a poor version of it. That’s not serving the long term public interest. And, you know, maybe I’m old school, but I think business and markets exist to serve the public interest rather than the other way around. And so I think that what’s happening now is to answer your question is that, you know, people are starting to ask these questions. I don’t think they’ve been asked because the incentives of the system are operating exactly as we should expect him to. So one of the things I discuss in the essay is that I don’t actually think that you could put it at the doorstep of any individual person and say, this person is bad or evil.

Tariq Fancy :

I think that a system works according to how we should, we should think it should work according to the incentives of the people right now, for the most part, the average CEO is very short term incentivized as well as the average investment manager. So they are the average CEO pay is 320 times. The industry worker that’s the highest has been in decades. The average CEO tenure is five years. That’s the shortest has been in decades. And so very clearly, you know, capitalism from the perspective of not just managers who are, you know, who are folk, who are incentivized towards profit, also fund managers, they’re, they’re very short term oriented. And it’s important to note that they also are legally obligated to choose, to chase profits, right? It’s not like they’re, there’s a sort of caricature of the CEO as being sort of this [INAUDIBLE] individual who has in their ability to, you know, the, the controls to do all the right things in safe society, if they want, I actually think that’s unfair even to the average CEO or fund manager.

Tariq Fancy :

I mean, having being a portfolio manager myself, once I know that, you know, you are bound by obligations around fiduciary duty, right? You’re focused on dollar value, right? Not, not social values. And you’re also financial incentivized around return. And so the idea that the industry has pushed is that while ESG integration is a, win-win why, because ESG is good for investing. So we are going to do more of it. And a, that’s not, you know, out of the bounds of fiduciary duty, because again, it’s not, it’s not the old school, what people use to think, which is that it’s gonna cost you money to do good. Somehow this new thesis has been weaved and no, no, no, it’s, it’s good for investing. So therefore, number one, it’s fully compatible fiduciary duty. Number two, you don’t need to worry the industry is gonna do it all by themselves because it’s, it’s, it’s good.

Tariq Fancy :

And why wouldn’t we do it, right? Like, you know, you can trust us cuz we we’re profit seeking and there’s profit there. And I think that the, the, the central part of the debate that needs to be addressed is the idea that that, that is frankly not true, right? ESG being better for investment returns is financial jargon proxy for you know, profit, responsible companies are more profitable. The fundamental problem that in our society that we all kind of know intuitively and certainly across the data of the largest asset manager in history is that our, our fundamental issue is that there’s a lot of things that are being done in society today that are not good for the public interest, but they’re being done cause they’re profitable, right? Burning fossil fuel today is cheaper than it needs to be for us to make the transition that we need to make.

Tariq Fancy :

And so for decades, as in using this one, as an example, people have said, we need a price on carbon, right? I mean, that’s pretty simply the answer like you, you have to tax the pollution. Otherwise there’s no disincentive to do it as much. And in response, we’re not getting a carbon tax and we’re getting a bunch of anecdotal stories about, you know, green is growing and this and that and you know, that’s it sound good. But once you dig below the anecdotes, the numbers are clear that we’re not moving as fast as we need to move. And, and I think that fundamentally the, the ESG thesis itself is flawed. It seems designed more to, for the system to optimize delaying taxes and regulation, and then selling a bunch of high fee products in between to address social lengths than it is to actually solve these problems and sorry for the very long answer. But the fundamental point I say at the end day is in a short term oriented system. You need regulation to solve these problems cause if you just leave it to the market to fee, correct, it will not work.

Ross Butler :

The solution you’ve already alluded to is very simple to say, which is a carbon tax taxes are tend to be national. Surely it only makes sense if it’s international, if not global I mean, how do we move forward there, if that is the solution, do you see you know, do you think this is feasible?

Tariq Fancy :

I think it is, but I think it’s feasible only if we bring the debate to the us. So I’m a Canadian I grew up in Toronto, went to university in the US and then spent most of my working career here. I’m, I’m physically in, in New York at this minute. And I will tell you that the Canadian side, there’s not much, we, it can get done alone, right? There was just an election in Canada. Climate change comes up a lot. There’s obviously challenges cause of the west of the country has the [INAUDIBLE] region. It’s politically tricky to, to, to figure out a national approach and you could argue that’s the same for all countries. They have internal challenges around it. And then a lot of them look and say, well, what does it matter if no one else is doing it? And I, and I personally think that the United States, there, there is a way to get a global approach, but it has to begin in the us because if the us like this decade still has a position of leadership that people may argue won’t exist decades from now.

Tariq Fancy :

But I do think in the 2020s, it’s true that the us has unique position lead as well as frankly today in administration that believes it’s science, which, you know, we, we, we take for granted, but you know, a year ago the president told people to drink bleach in the face of a hundred year, you know, the biggest crisis a hundred years. And so, you know, we do have a moment in history for the next few years where the preconditions are there. But, and I think that if the us were to lead, I think you’ll find that the Canadians will fall. The Europeans will fall the other streaming to follow. Cause I can tell you one thing as a Canadian, no Canadian political party wants to be seen to be the right to the right of the us on issues like this. Right? And so the us has an ability to lead, you know, as a, as a side, interesting tidbit in my paper, I use the analogy of competitive sports.

Tariq Fancy :

A lot. I lean into basketball. Originally when I wrote it, I use soccer. I’m a huge football or soccer fan. But I switched it to basketball precisely because I thought, well, you know, there isn’t, there is a global approach that can work. I really do think there is just like right now countries are looking at coordinating on taxes, same idea, but that came about because the Biden administration sort of said, enough is enough. We need to work and coordinate on minimum taxes. Otherwise people just came the system it’s politically difficult for the Biden administration to do that for climate change. I do believe they would do it. I believe that if there was the political room to do it, they would step into it. But that politic room doesn’t exist. If the business community is unified in what I think is a completely VACU thesis that in 2021, we can rely on the free markets to like correct, you know, the largest market failure in history.

Tariq Fancy :

And so really long way of answering it. I think the debate it’s the us business community needs to be, you know, that’s where the debate needs to happen. Because I think that if you get to a point where you can actually split the community and say, listen, like what’s being done right now is not even in, in the interest of people at BlackRock who are in their twenties and thirties, right. To kick the can down on the road, on these issues. And that there’s a large intergenerational issue that’s being unaddressed. You do get to a point where you can start to actually create a debate that I think gives the politicians here room to move. And I think if they can move, I do think that there’s a global approach. That’s possible.

Ross Butler :

I like the idea of a carbon tax, because it’s simple. And I think with a complex problem, like climate change, you need to keep the solution simple. Otherwise you just get in a, in a model and you’re not gonna bring people with you. But it’s only simple to say it’s actually very complex when in practice. So for example it’s always important to work out what the unintended consequences of any interference in a complex system is. And there will clearly be consequences that are negative for people and they will be unequally distributed. So for example, many, you’re a concerned that if you raise the price of energy, it’s the poorest in the rich countries and, and the poor in the poor countries that will, that will be hit hardest. And so in order to get this through these big political questions need to be dealt with satisfactorily.

Tariq Fancy :

I would agree with that. I think, you know, know I’m actually not that worried about challenges like that. And the reason I’ll say that is that there’s no shortage of good ideas to address that. I mean, I think there was two years ago a huge number of economists, including 45 Nobel prize winners endorsed the idea publicly of a, of a price on carbon. And I think for that specific endorsement, it was in the idea behind, it was very much openly around the idea that the carbon tax should be revenue neutral or in some way that the proceeds of it should be distributed towards those who need most. And so for them actually, they may pay a little bit more at the pump, but then they’re getting much more back in, you know, a set of other you know, social programs that could be things dedicated toward education.

Tariq Fancy :

It could be just cash dividends. And of course the richest would be the ones that’d be paying, cuz they’re gonna pay the carbon tax just as much. You know, another sort of taxes probably around that, but you know, not not necessarily receive it back. And so in that sense, progressive rather than the regressive tax, I don’t think there’s a shortage of ideas to do that. I think the problem is that right now, for the same reasons you can’t increase taxes on wealth or any, or you know, or marginal taxe rates on the wealthy, which, you know, have of being shorter, being lows have been in decades. And you know, the economist, Tom Boetti has written a lot about sort of the growth inequality as, as you know, as partly as a result of that, you know, you kind of have a situation where the solutions are there it’s politically difficult to get them done.

Tariq Fancy :

And I think that’s largely because, you know, I think that right now the, those who have power are sort of beholden to a set of fantasies that say that they can sort of keep, have their cake and eat it to. And so sustainable investing is a great idea for them, you know, Davos and all of these gatherings of the world elite, they seem to always land on solutions that don’t involve taxes, regulation. I get it. Nobody wants taxes and regulation, right? I mean, that’s not something that anyone wishes, I’m a capitalist I’m former investment banker. It’s not the kind of thing that I, you know, we rerun and, you know, are desperate to see happen, but at some point in a competitive market, it’s kinda like a competitive sport, right, where you’re playing and there’s dirty play, right?

Tariq Fancy :

Dirty plays, winning games. People are doing things that no one wants in the game, but it’s, it’s, it’s because the rules haven’t been updated for decades and they’ve figured out ways to, you know, effectively score points and win games by, by being on sportsmen. Like you need referees, right. And capitalism has referees there’s Ru you know, there’s no such thing as a free market. That’s an idiotic idea. Every single market has rules. Right. Right. I mean, the first lawyer you talk to will say, no, no, market’s a collection of rules. Those rules needs to be updated significantly. Right. The thing about a carbon tax is that the crazy thing is we’re, we’re only we’re discussing now that we probably need one soon, but people knew that a decade ago. Right. And, and all that was sort of seen is that I would argue a consensus that emerged in the 1980s, that was sort of a Thatcher Reagan consensus around the idea that free markets magically solve all problems.

Tariq Fancy :

In some cases, of course, you know, deregulation makes sense, but it’s been taken to an extreme where even post-financial crisis, we haven’t seen the kind of regulation we would need, nor are the change in narrative that like the free markets have got this figured out. And in 2021, you know, the solutions that we’re banding about. I mean, again, as people who have won Nobel prizes for saying, we need a carbon tax there’s nobody who said even vaguely serious economists, who’s talking about ESG integration as a way to fight climate change, low carbon ETFs, you know, proxy fights against oil companies, one by one. I mean, they know that these things don’t work. You need to address a systemic crisis. You need systemic solutions. Those have to be led by government.

Ross Butler :

It’s interesting what you say about the, the free market being rules based, you know, I completely agree. And I think Thatcher and Reagan were they, they were operating in a moment of time with, with their own political pressures. But I think the philosophies on which their doctrines were based would not didn’t disagree with that. Like Hayak or Milton Friedman. I think all of these people, they, they don’t see freedom as as an ANM or, you know, they don’t see freedom as a situation with rules. That’s just chaos. They see freedom very much. I think, as you describe it, which is a rule based game and freedom is a principle whereby most of the rules should respect the integrity of freedom, but that some of them have to, you know, so I think Hayek in particular mentioned a pandemic as a situation where state and intervention may be required.

Ross Butler :

So I don’t think the free markets unnecessarily in opposition to the concept of, of intervention. And the other thing I was thinking when you were speaking is that it’s very easy to pontificate from a high, you know with a very well paid job. And it’s much harder to do good on the ground and to do good on the ground. You typically the make personal sacrifice, and then you can get a real feel for, well, what are the impacts of certain policies on actual people? And so that’s why I find your, your bio interesting, because you’ve been a venture capitalist and a private equity guy and a big institutional investor, but you’re also thinking about Afghan girls and the impact of, you know, the current situation on them right now and how to get to them. And I think you need that bridge between lofty political ambitions and you know, what’s actually happening to real people in order to like, stay that your policy ideas you know, will play out the way you think they might in, in the real world.

Tariq Fancy :

I agree with, with that. I think I, I agree with everything you just said. I think that you could take an approach based on the power of markets and still, and still say yes, but markets need rules and those rules need to be updated to, to, to serve where we are in 2021. And, and, and I’m not an expert on, you know, Thatcher Reagan historian or, or even Milton Friedman. But what I know of all of them is certainly Milton Friedman was that they would probably agree with the carbon tax at this point, because, you know, it’s fairly clear that that we need to do something and fast and that, you know, announce of prevention is worth a pound of cure. And, you know, so time is of the essence. And I think right now, what needs to happen is that business leaders who understand that we need to, to make serious changes and quickly need to rise above their own short term interests.

Tariq Fancy :

And that might mean that asset owners are the ones that start doing it, the clients of asset managers, or it is excos, or, you know, types of people who, you know, they’re willing to stand up and say something that may not be in their own interests in the same way that, you know, Warren buffet, 10 years ago, RO rode oped saying that, you know, he should be tapped more. And so I think I, you know, and I would also add like, there’s, there’s a lot that people can do, even from the business side of things. I mean, I, I think, you know, obviously there’s, you know, you can run an NGO like I am, and of course people can support using a technology based model to sort of support our work, to grow that and, and impact more Afghan women. But even if you are sitting in a company and you have a specific role, there’s a lot good that can be done.

Tariq Fancy :

And I think there’s a lot of room for CEOs to do better right by, and, and so I don’t think that they, that it’s all lying when they go on. They say they want to pursue the social good. But I do think that there needs to be two things. Number one, there needs to be more rigor around what’s being done, because if the incentives of the system are set up in a way that it’s cheaper to market yourself as being sustainable than it is to actually make the long term investments to be sustainable, then we have a problem. And again, when capitalism is so short term oriented, that, that it seems to be what’s happening in a lot of cases. And while, while you hear a lot out about ESG, but then somehow we’re not making any progress on our social sort of challenges.

Tariq Fancy :

And then the second thing, and then the most important thing is that as, as much as I’m a capitalist and spend most of my career in the private sector and, and, you know, as a, as a fund manager and other things, I would also say that it’s important. We understand the limitations on what the system can provide, right? Mean businesses doing right by stakeholders. That’s a great idea, but we can’t rely on that. Just like we can’t rely on a system that’s built out of a series of transactions that are based on fiduciary duties and other things that are meant to maximize profit. And then look at that existing, alongside a market failure, where obviously it’s cheaper to do lots of that. We need less of done, you know, any way you look at that system, it’s gonna produce suboptimal outcomes. And I think that right now, I think, you know, there’s a real battle for the future of capitalism where I, I think that and it doesn’t just have to be younger people who are sort of saying, wait a second, you know, we’re on the hook for this we’re capitalists, but it needs to look different.

Tariq Fancy :

It’s also, I think a series of, of business leaders who really understand the importance of, of saying here’s what business can do the way it’s set up. And there’s a whole bunch of amazing things, but here’s a limitation on what business can do unless we change the rules, which is just like an athlete on the field saying, listen, like at some point I don’t wanna be playing in a game where, you know, the, someone punches the defender so they can go, so score a goal, like, you know, we need a referee. And I think that that’s the debate that really needs to happen now. And I hope that that kicks off sooner than later. Yeah.

Ross Butler :

What’s next for you? Is Rumie sole focus ?

Tariq Fancy :

Rumie is my sole focus right now, right now, the, the kind of impact that we can have scaling technology across millions of people through their mobile phones and markets, like not just Afghanistan, actually also in north America or other biggest growth areas or in north America using some new tools with built around mobile first micro learning. It it’s done extraordinarily well, especially in the pandemic, it’s it it’s grown very, very quickly. And it’s, it scales very, very cheaply. So right now I think that there is sort of this step change or revolution we could drive in access to learning that is, is, is truly exciting. And because I, I started out as a tech banker in Silicon valley because I taught myself programming and actually did a bunch of internships and technology before ever citing to try out finance.

Tariq Fancy :

And then of course doing it as a, as a banker in Silicon valley. And so now I, you know, looking at the tech, the technology it’s possible, we see so many tech trends that are extraordinarily exciting, that the fact our everyday lives there aren’t enough. I think that really square or zero in on how to improve humanity and use all that, those tools and infrastructure to, to truly address things like the education gap. And that’s, and that’s really exciting for me. And that’s, that’s kind of the focus and the near term, especially on the situation in Afghanistan, because you know, the people there need all the help they can get. And we work with some really, really heroic women’s rights campaigners that you know, interfacing with them regularly makes me realize on some level, the privilege that I have, no matter what I’m doing, just because I was, you know, born and raised in north America and had access, you know, to pub great public education and other things that, that if I’d been born there, I wouldn’t have, I wouldn’t have ever gotten, you know, to ever see or touch.

Ross Butler :

Well, the very best of luck with it sounds incredibly worthwhile. And thanks very much for sparing your thoughts for Fund Shack.

Tariq Fancy :

Thanks for having me. It was a great discussion.

Ross Butler :

You’ve been listening to the Fund Shack podcast. Make sure you subscribe and visit our website@fundshack.com for many more video interviews. It’s the private capital channel alternative investment professionals.

#29 Luke Johnson, entrepreneur, investor, philanthropist

Fund Shack
Fund Shack
#29 Luke Johnson, entrepreneur, investor, philanthropist







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In his 20s, Luke Johnson led the acquisition of Pizza Express and as chairman, helped it become the UK’s leading pizza brand. He has since established and helped develop household names, Strada, Giraffe, the Ivy, Zoggs and Integrated Dental Holdings, as part of his family office vehicle, Risk Capital Partners.

He is a successful newspaper columnist, author, former chairman of the Royal Society of Arts, and current Chairman of The Institute of Cancer Research.

In our exclusive podcast, Luke provides a critique of private equity, a critique of public markets, a critique of lockdowns and some of the most sensible advice we’ve heard yet about how businesses should be run in this brave new world.

Uncorrected transcript\some inaudible parts

Ross Butler:

You’re listening to a Fund Shack, private chat number 29. Welcome to Fund Shack. I’m Ross Butler, and today I’m here with Luke Johnson, a well known entrepreneur, businessman, philanthropist, and private investor, Luke. Welcome. And I have to say thanks so much for coming to meet us physically, because this is the first time we’ve been back in the studio 18 months and personally I think it makes a real difference. Nice to see. I was looking over your bio in preparation for this. And I had to say, and I don’t say this just a flatter you, but I was amazed at the breadth of your undertakings and your achievements. So you’ve got obviously a varied portfolio. And within that I recognized about three quarters of the businesses. Now you do consumers, so maybe that’s not so surprising, but that leap out of me, then you’ve been a successful newspaper columnist over years, if not decades. And I know that that’s not easy to sustain and you’ve been very active on the philanthropic side. You’ve publish books. This is quite a productive repertoire. Now you only get one life, so it obviously doesn’t seem strange to you, but why do you think it is that you’ve managed to be so productive across so many relatively varied domains?

Luke Johnson:

Well, I think I’ve always liked to be busy and I have a father who has had an extremely long career and although he stuck to the one career of being a writer, a journalist and a historian, he, he was incredibly productive and wrote many, many millions of words and published 40 books and so forth. So I think he gave me a good example to follow as a role model. And you know, to a degree, I think life is what you make of it. And if you have the energy, there are always opportunities. I think given that most of us perhaps we’ll live to, you know, be in our eighties. That means we might well have a 50 year working career. And it seems to me, therefore that we should all plan to have at least two different careers and possibly more I’ve always been interested in people who’ve done a variety of things rather than just one profession and stuck to that their whole working life and then retired. None of that interests me in the slightest.

Ross Butler:

It rather goes against the grain these days, cause everyone wants to specialize to such a great degree. And if you’re seen to be your specialist in more than one area you’re seen as an amateur in at least one of those,

Luke Johnson:

Well, there may be some truth in there. And I think I could be accused of being a [INAUDIBLE] at some things in life. And you know, I don’t deny that if you diversify, then you may have less depth and you know, there are advantages to focus and specialization, particularly in the modern complicated world. However, the point you made at the beginning is we only have one life. It’s important to keep interested and lively. I think for example, take philanthropy. I’ve served on the boards of a number of different charities and nonprofits over the last few decades. And one of the great advantages of that is I think it teaches you things and you meet people that if you are only doing business, you wouldn’t. So I would actually encourage all successful people in sectors like private equity or venture capital to seriously consider whatever age, but say in their forties, the idea of becoming a trustee of a school or hospital or some other nonprofit, because I think it broadens your horizons. And that should be partly what life’s about. I think there is a risk if you only do one thing, you get dull and you repeat yourself and the needs to be more to it than that. I think.

Ross Butler:

Yeah. investing itself is very nature. Kind of it’s, you’ve gotta have a broad outlook on life because you know, you’re looking at different sectors. You are not the specialist, you’re not the, in most cases, the executive, the doer, you’ve gotta stand above that. So that will kind of make that, that probably adds to your ability to be a successful investor.

Luke Johnson:

Maybe I think one of the challenges for private equity is that although they pretend to themselves, they aren’t the specialist in terms of how to run a business or a particular industry. I’ve sat on boards with private executives who are there telling the managers how to run the business and making decisions that I think should be delegated to the executives who are full-time in that business. And the arrogance sometimes are private equity executives in thinking they know best let’s them down. I think there are some areas where private very good, you know, buying and selling for example, raising finance, they’re pretty good at that. Some of them are pretty good at picking talent but above and beyond that, you know, knowing markets, knowing competitors, you know, understanding the intricacies of the technologies that they’re working with, really being able to spot the best executives at the operational level to work with. Mm not so sure

Ross Butler:

I’m sure you’re right. And I actually, I think I do agree with you, but to play devil’s advocate slightly, if it didn’t work, would they, would they do it? It’s certainly the trend is for greater activism and certainly the institutional investment community buys the idea of interventionists private equity firms. So presumably they look at the data and think, well, those that are a bit more muscular in their approach with executives do better. There must be some cause in effect,

Luke Johnson:

There probably is if they’re the right private equity firm and as you well know, you know, it depends which quartile of a PE house you are talking about. I think we’re all humans and I think private equity investors have as much ego as anyone. And, you know, according to Maslow’s hierarchy of human needs, once they’ve developed a certain quantity of wealth what’s next, and obviously what’s next is some degree of status. And that would mean them adding value and making a difference and being important in the ownership so that the value accretion is partly thanks to them. Now, I would normally accept that the financial engineering aspects of deals are probably down to the PE house. I have they bought it on a low, multiple, can they sell it on a high, multiple, have they added the right amount of lever to goose the returns?

Luke Johnson:

Have they made a clever bet in the first place? All those things of course are down to them, but, above and beyond that, you know, quite often I think, you know, it’s debatable whether they really make a difference. Now, I think there are some very good private equity investors. And I, I would say on average, you know, successful private equity investors are clever people. And, you know, obviously if they succeed and they, you know, get backing from limited partners and, and show good returns, then they can’t be that thick. However, it’s amazing what lever in a rising market can do.

Luke Johnson:

And, you know, generally speaking over the last two decades, certainly, you know, it’s been a pretty good game to play. I would say private equity in terms of accumulating returns for investors and indeed enriching private equity investors. I think, and I’m not talking about myself so much, cause I’m not really an institutional private equity investor or executive, but I think it’s as good a career as one could pursue, if, you know, you want to get rich in a pretty safe way because you are playing with other people’s money to a very large degree and you know, you can write very big checks. And so if you get your bets right, then you do extremely well. And to a large degree you know heads say wind tails, other people lose. So, you know, private equity as a career has proved a pretty good bet. And I suspect it will continue some time because you know, there are a lot of organizations raising big funds and there’s a lot of parcelling which to a degree, you know, is self-fulfilling

Ross Butler:

So, you’ve packaged yourself up to some degree as one of those people, because yes, you are not an institutional, but you’ve got risk capital partners. You could have just been Luke Johnson, the big wealthy investor, but for some reason you see it as useful to be seen as part of that community.

Luke Johnson:

Well, I think probably a lot of people prefer to deal with a brand, an organization rather than an individual. I think an individual is more egotistical inevitably. I think when we set up risk capital partners over 20 years ago the sort of private office was much less common, I guess, if one were doing it now, you know, that’s what I would do. Also. I have more money now than I had 20 years ago. In the meantime, we also did raise a fund with limited partners. And you know, it’s say for one, an investment is now spent and we’re returning funds and it will show a good return to our LPs. And I think it’s been a success, but I didn’t wanna do another one. The point about a fund of course, is it’s a very, very long term commitment.

Luke Johnson:

It’s really a 10 year commitment from all the partners. And indeed obviously the limited partners. So it’s a very unusual structure in terms of most jobs, if you like. And, and it, it really is a partnership arrangement rather than employment arrangement and all the longevity and loyalty required that, that displays. And indeed, I think if you look at the history of most PE houses that have fallen apart more often than not, I would say it’s cause the partners fell out, you know, and that may have been because they made some bad investments, but quite often it’s literally personality clashes leading to the, you know, founding partners of the organization, not getting on etc. And that’s what leads the LPs to then dessert them. But I’m not in denial about the fact it’s a lucrative and on some levels successful structuring of buying assets, because I think there will always be the advantage they have over say, public companies in private equity are virtually, always willing to buy and sell.

Luke Johnson:

Every asset is for sale. And they are always willing to buy a new asset. Public companies are slaves to the cycles of the stock market. And very often in my experience, public companies are forced to sell at the bottom and buy at the top. And it astounds me how often I come across situations where there’s a public company in a particular sector that will know that industry very well and have huge synergistic advantages of making a strategic acquisition, but for a variety of reasons, they’re too slow or it’s at the bottom of the market or whatever. They can’t make the acquisition private equity, which doesn’t know the industry as well. And doesn’t have any synergistic benefits makes the acquisition and then flips it to the industrial buyer a few years later at a huge profit. And, you know, you wonder why does the public market always end up paying more? And I guess it’s because private equity are ultimately really M [INAUDIBLE] specialists, all they do is buy and sell in a sense. And that’s what they focus on. They’re small and flexible and they have this great timing advantage, which really plays to their strength.

Ross Butler:

I agree with you. I think it’s it’s one of those things and there isn’t a problem with it. As long as the, those rewards are accessible to as many people as possible. One of the problems is that anyone can invest in the public markets, but it’s, it’s increasingly easy to invest in private equity vehicles, but it’s still pretty difficult for your average job.

Luke Johnson:

Yeah. And of course, as we know, private equity still only represents a tiny proportion of the overall savings and pensions money out there. And as a proportion of overall institutional individual portfolios, it is growing, but it’s still, I would imagine worldwide, you know, under 10% across most diversified forms of savings. And it, it is gonna grow structurally more allocation is gonna be devoted towards private investments once or another, be it VC or PE. That’s probably a good thing. I’m not surprised even though, you know, two and 20 relative to public market management fees is I, the level of attention required investing in private companies is a great deal, more intense. So, you know, I would argue it’s, it’s justified to an extent and the returns are there. And another area where I think private markets have an advantage is they are more willing to put higher levels of debt into investments. Generally, my experience public company fund managers, don’t generally like to invest in companies that have 3, 4, 5 turns of [INAUDIBLE], senior debt. Whereas many PE houses are perfectly comfortable with that. Indeed. They would consider that a standard lever of leverage for a normal buyout. So, you know, that financial engineering in rising markets and growing businesses, compounds returns. Yeah. And  it’s an another advantage that PE has over public markets. So

Ross Butler:

Just at this point, can we step back to some of our international listeners might be wondering where have you come from, if you are not a mainstream private equity guy, could you give us a quick potted history, maybe looking, starting with, well, wherever you like, but particularly like Peter express as a signature deal.

Luke Johnson:

Sure. Okay. So in my late twenties I, and a, a group of partners took control of a private business called pizza express. We merged it with a a group of franchise restaurants, pizza expresses, arguably the leading pizza chain in the UK. It’s been going since 1965. We took control of that in 62, 63. We took it public.

Ross Butler:

Wasn’t it ’82?

Luke Johnson:

No, ’92, ‘93.

Ross Butler:

Sorry. Okay. Sorry,

Luke Johnson:

Go. I’d only just graduated from university in ‘82.

Ross Butler:

You said ‘62, so yeah, you’re Right.

Luke Johnson:

Yeah. ’65. It was founded. ’92, ’93 we took control of it. We took it public, and it was very successful. And I was chairman of that during the nineties and, the chairs rose from 40p to eight pounds more. And, off the back of that, I then started doing more deals. It initially mainly public company deals. And then through the later nineties and into the two thousands, many more private companies, and, you know, over the decades, I’ve probably invested as principle in 50 or more businesses with a strong bias, as you said, towards consumer and in particular areas like, hospitality and leisure, mainly UK. And you know, at the smaller end, I, I would characterize the classic investment I do as development capital. That’s my preference.

Luke Johnson:

So frequently backing a founder not always taking a majority stake, quite often, a minority stake. Yes, we do buyouts, but quite often, not and pretty flexible in terms of the types of deals we do in the structures. And I think that’s because to a fair degree, most of the time we’ve been using our own money, my money. And so we can do bigger and smaller deals. We can do longer deals. And clearly we don’t have to do any deals at all. I think one of the reasons I chose not to raise a fund when our last one was exhausted was, as I say, it’s a 10 year commitment. I’m 60 next year. And I didn’t wanna be marching into my sixties with a sort of, you know, seven, eight year commitment still to go of making, you know, a minimum number of investments and a minimum amount of capital deployed every year.

Luke Johnson:

And it’s been very interesting to me over the last 18 month, with the pandemic, a lot of private equity houses, particularly in 2020 sat on their hands grave mistake. I think they should have been out there doing deals. And you know, a lot of them were underinvested. Anyhow, they had a great deal of dry powder. They’re now even more under invested and they under are under huge you to invest. And, you know, ultimately a P house that doesn’t get money to work is no good to anyone. Mm. So they will get their money to work. Unfortunately they may well end up paying too much. Now, usually private act is pretty good at avoiding those sort of cycles, as I said earlier, and, you know, they’re astute people, private act invest. So they’re very reluctant to overpay, but I sense that quite a lot of houses have got their back slightly up against the wall in terms of the pace of investing. And that’s not a comfortable place to be. And I’d much rather be in a situation where you take a year off. Things are too pricey. Conditions are too difficult. I won’t be investing this year. And then do twice your usual number of investments when times are good for investing.

Ross Butler:

Yeah. So you have that flexibility, which is an advantage. We come back to maybe the structural advantages, but you mentioned you were active in 2020. I mean, what’s your view of the market and opportunities out there?

Luke Johnson:

Well, I’m very much to niche investor. So, you know, I’m not putting a hundred million to work a go or 200 million, whatever it might be, you know, I’m investing five, 10, 15 million pounds in each bet. And I think in the end of the market that I tend to operate in, there are opportunities two or three of the deals I’ve done in the recent past have been distress. And there’s obviously some of that going on, particularly in some of the sectors I’m familiar with. And those are deals that the vast majority of private equity houses are not geared up to do. Don’t feel comfortable doing for all sorts of probably good reasons.

Ross Butler:

Um there’s not much experience of doing distress deals.

Luke Johnson:

No. I mean, there’re obviously a handful of specialists that only do them and some of them are very good and really I’m really impressed by the quality of some of those deal doers.

Luke Johnson:

But they tend to focus only on that. Again, they would tend to be doing slightly bigger deals than me. And some of the deals I’ve done over the recent past has been modest if any competition, which, you know, for most private equity players is very hard to achieve. You know, generally speaking, every single deal is got proper advisors and intermediaries and is well marketed. And you know, the, the assets touted widely around the market and there’s plenty of competition and you get a, not a perfect market, but a pretty good market price achieved for most assets of quality and, and size. Mm.

Ross Butler:

Would you say that so I’m just trying to get to grips with what the secret of your success is. Would obviously you can’t put on a, on a napkin, but I’m wondering if to what degree would you say you use your intuition when you are assessing whether something is a good opportunity versus bringing in the advisors and producing reports for, you know, like, so a typical investment executive would then have to go to an investment committee and it would be a group decision, but it would also be a real discipline in terms of dotting all the eyes and crossing the Ts and making sure that there is a really explainable, calculable case. You don’t have to do that. So you can rely more on your intuition, to what extent do you?

Luke Johnson:

Well, I think having the discipline and having group input is vital. And you know, there have been occasions in the past where I have not been as rigorous as I should have been, not within our fund, but with my own money. And sometimes it’s blown up in my face and I, you know, I’ve tended always to be at the sort of higher risk, higher reward end of investing. So, you know, I’m much less interested in steady investments that will, you know, gradually make me twice my money. I’d prefer to go for things that make me three or four times my money, but occasionally go wrong and you lose everything. And obviously that’s highly undesirable and never part of the plan, but it can happen in life. It, it normally it doesn’t actually happen with deals. I do because of leverage it’s because the business hasn’t worked.

Luke Johnson:

I do use intuition and inevitably we are, you know, social animals who you mentioned at the beginning of this meeting, how much better it was face to face than on zoom. I completely agree. That’s all about what you might call intuition and being a human being I think private equity investors who pretend to themselves that it’s all science and spreadsheets are under an illusion. Hmm. I suspect none of them do actually think that because otherwise they wouldn’t be successful. No, I think having checks and balances is essential and they come in all shapes and sizes, not just credit committee, but of course, lenders and others will have their own, you know, impositions, I think relying exclusively on, you know, the accountants and lawyers and other specialist advisors to tell you all about the business, rather than doing any of your own personal due diligence.

Luke Johnson:

And having at least some in-house capacity of taking a commercial view on a situation and the people running it and so forth is a mistake. And you know, I have to say having worked with some bigger PE houses, some of them are very good at all that both having in-house resource, but also getting incredible work from advisors. So I wouldn’t to cry any of that at all. I think it’s important not to bely obsessed about the reports. I think you have to look at the big picture. You, you almost certainly, at some point have to take a view. I think sometimes, you know, I’ve seen PE houses miss a deal because they let relatively small issues cloud the thing, and someone else is more willing to step back and say, you know what, nothing’s perfect, good enough. I like it, etc. And it’s the right price and so forth.

Ross Butler:

Um you mean, a bias towards optimism to some degree?

Luke Johnson:

I think anyone in capitalism does. Yes. You know, if you don’t believe in growth and you don’t believe in a positive future, and you don’t believe in the potential of the business, you are backing to deliver value, then you probably shouldn’t be taking money on it. So yes, and I think probably ultimately most PE houses have that frame of mind or the individuals working in them. And so they should and obviously, you know, as well as making a turn on the multiple and the magic of leverage, the other biggest element in any private equity successful investment is growth. That’s the thing that will ultimately deliver the really great return growth. And indeed, it’s also what the buyer at the other end looks for. You know, I have occasionally invested in businesses that have very little, if any growth and they’re quite hard to sell because, you know, people don’t want to really invest much in stagnant businesses. And why would they, you worry that if he’s not going forward, he’s probably going backwards.

Ross Butler:

Yeah. You alluded to the fact earlier that you invest in relatively small deals and so they can be the specific situations that you’re assessing, but particularly I’d say at the moment, is it not increasingly important to take a more of a macro view as well, given the interventionism, let’s say of the state in various sectors are you having to, are you trying to factor that in, when you look at new businesses in areas that could be locked down?

Luke Johnson:

Well, it’s a very serious point and pretty profound for anyone who’s involved in markets and free enterprise and so forth, you know, have the rules of the game change such that the government will force you to shut in a way that would never in modern history of happened before and, you know, destroy the value you are trying to create here. I’m sort of without being ostrich like about it, I’m of the view that these are things one cannot influence, and generally, therefore you can, you know, give yourself a hashtag stressing about them all night long. I think you have to try and focus on your own specifics of situations where you can make a difference both in your own life and your business. And I guess I’m taking a view generally that, you know, with regards to, for example, lockdowns, which have been impacted certain sectors, like travel very severely indeed, ultimately society can’t afford many of these more.

Luke Johnson:

They’re just too expensive, both economically, psychologically socially. And so you know, the harms, the undoubted damage of lockdowns are becoming ever more apparent as was obvious because they’re diverse and long term, whereas of course, daily hospitalizations of and deaths from COVID to, you know, on a daily basis. But you know, governments can’t keep printing money. I don’t think in the way they have done to pay the bills. And you know, some of the bills for both businesses and governments are starting to fool you we’ve got threats like inflation. So and so on. So big picture means I don’t think, you know, countries like the UK and many others can really afford to do many long lockdowns let alone the fact that I think proof will recently show they don’t make much difference. So they really aren’t worth it, both health wise and wellbeing as well as economically.

Luke Johnson:

And therefore I think, you know, it’s probably a pretty good time to take a view and say obviously to a large degree, thanks to vaccines, but also the, the terrible costs of the interventions are such that they cannot be repeated again and again. And so as people keep saying, we have to live with the endemic disease and get on with work and, you know, start earning some money to pay the bills, which means decent businesses that might be shut down. If there were another lockdown are probably a reasonable bet, but there’s gotta be a discount somewhere in there. And, you know, clearly if once constructing portfolio, you don’t want to bet exclusively on businesses that are vulnerable to being shut down. And I know one or two PE houses where, you know, big chunks of their portfolio have been closed for much the last 18 months. I’m very lucky and is absolutely luck that I’d sold a whole raft of businesses over the previous couple of years, which would’ve been smashed to pieces by lockdowns. And thank God I did, because it meant that although I did have certainly a couple of businesses that are, you know, in sort of recovery mode, we say having been severely battered if I’d had a half a dozen of them, it would’ve been significantly worse.

Ross Butler:

Yeah. I think you’ve gotta be right to just focus on what you can influence. And yeah, I do find it surprising that there’s so little commentary on the potential fallouts, like economists used to issue, press releases. If we had a public holiday telling us how much it costs the British economy, and yet we’ve been impartial lockdown for two years and well, they don’t issue, press releases about it generally. It’s like, it’ll be all right. We’ll just go along as, as if nothing ever happened. So I think, I think you’re right. You have to just focus on what you can, what you can influence, but there probably will be a reckoning.

Luke Johnson:

Well, I think there needs to be reckoning because I think overall it can be argued that, you know, in certain ways society slightly lost its marbles over the last 18 months. I think the toll across many aspects of communities in terms of, for example, children and education, young people, generally, the damage to them the irrationality and lack of evidence base for some of the interventions and so forth and so on. You know, we don’t want to get distracted into that black hole. I is such that you know, in hindsight, in the years to come, I do think we will realize that grave mistakes have been made and I’m not talking about, you know, locking down two weeks too late. I’m talking about the very essence of universal lockdowns and the harms of, you know, unemployment and you know, the, the divisions it creates in society between those who have to still go out to work.

Luke Johnson:

And those who think that everything now is working from home for forever speaking personally, one of the toughest aspects has been, people thinking in a rational way when they’re all isolated. Yes. And I think for myself, and I believe for many others that actually you get things more right if you are debating it with others in person. Mm. And I think the idea that we’re all thinking rationally because we’re on zoom calls is diluted. I think there are very profound differences. I know for myself, I’ve had hundreds of zoom board meetings and such like, and I can tell you now they are very, very dysfunction compared to a proper board meeting with people in the room. Definitely no question of it. And for example, if you’ve got a large board and most large organizations and institutions have large boards, there is a massive predisposition towards people, not dissenting of any kind, when there’s a certain number, people on a zoom call, they are much more likely to stick their hand up or nod to the chair or do whatever it is to say, yes.

Luke Johnson:

I just wanted to bring up this one point. Can I just question this it’s extraordinary, how often a non-executive argument will do that and then two or three others will say yes, yes. I was wondering about that does not happen on zoom calls. Yeah. And you look at our leadership and the key advisor groups, for example, you know, in public health and others that have been making these draconian and extraordinary decisions all on zoom, not good debate, not good vigorous discussion of what are the, you know cost benefits of this. Have we thought of the whole picture here? Mm. And I think that’s been going on a great deal. And I think because we’re all snug at home, particularly those better off powerful people who run society in industries like private equity. The fact that, for example, you said at the beginning of this meeting, this is the first time I’ve had one of these interviews for 18 months. I can’t tell you how many conversations I’ve had like that, because I’ve been in my office and meeting people if I possibly can since May last year. Right. But every banker, every accountant, virtually every institutional person I know of fund manager, PE executive has been at home the whole time. And I don’t think that’s conducive to critical thinking. And

Ross Butler:

It’s so easy to say, well, what’s more efficient, you know, everything

Luke Johnson:

It’s convenience. Yeah. Convenience. Yes. You’re right. Efficiency is the wrong word because efficiency suggests getting it right. It’s convenient. It’s a bit like getting home delivered food. It’s very convenient, but mostly eats. I’d rather eat in a restaurant or have proper cooked food at home after you’ve done some shopping, then a crappy meal that is probably more expensive home delivered.

Ross Butler:

And yet it’s harder to articulate the benefits cause they’re slightly intangible and they they’re harder to, to put hard quantification on. And you also kind of alluded to the, everyone talks about quality these days, but there is a real inequality element to this whereby white collar workers like you and I could choose just never leave our homes again.

Luke Johnson:

Ft and economist readers love it all. Yeah. Because they run the world and they’re very comfy. They’ve got gardens. Someone collects the rubbish. Someone delivers their food. They, you know, get stuff on Amazon. They might see more of their family. What’s not alike and they’re safe. Meantime every year, every day in Britain, 10 million people are having to go out to work, to keep the broadband going and to deliver the groceries and so forth. And that is a more pronounced inequality on many levels than I think ever in our lifetimes. And you know, there are so many serious issues arise from this such a for example, has furlough undermined a chunk of the portions of the nation’s work ethic, you know, and it’s peak 9 million people being paid to stay at home. Why wouldn’t they want that to continue? Is the real reason people are willing to accept low quality output from working from home because it’s saving the money on commuting. I think that’s a big factor as to why lockdowns have had such enormous support seemingly. It’s not the science it’s because people are saving money on their fairs.

Ross Butler:

What’s your policy preference with regards to the companies that you own?

Luke Johnson:

Well, I want them in the office now it’s obviously up individual bosses. I would say, you know, if they think they can run things efficiently and you know, it makes more sense for their particular shape of their workforce to do it at least partly from home a hybrid model, flexible. I get it. And I think workforces these days will increasingly demand that and companies that insist everyone is in the office every day may struggle to recruit or retain people.

Ross Butler:

Although young people might find it more attractive.

Luke Johnson:

Of course. And I know I do. And I think there are, it depends on the big and the industry and the people in the work. UI guess people in my generation are much more likely to say, we’ve all gotta be in the room. Those who are, you know, much more used to the flexibility, should we say video conferencing might argue, no, let’s stick to what we’re doing now. And of course there are lots of things that can be done perfectly competently online rather than in person, but when it comes to anything critical, a key pitch or, a key sale or, interviewing someone to hire them or whatever it might be that really matters, then I see there is no substitute for doing it in the room. And, h passionately believe that. And I think actually it has been a competitive advantage, I believe over the last year in doing stuff that I am in the room when people are willing to be. And, h think it’s helped clench deals and given me an insight that people who are relying exclusively on zoom, you know, I’ve missed.

Ross Butler:

So the Woody Allen quote, which I’m gonna get wrong, but two thirds of success is showing up

Luke Johnson:

90%.

Ross Butler:

We’ll go with that. Leave us with something optimistic, positive. Can you tell us about deal you’ve got in your portfolio, you like the look of, or something about the world that you are optimistic about?

Luke Johnson:

Well to use that bogus venture capital phrase pivot, I have slightly towards areas that are more digital inevitably because historically, you know, I’ve invested heavily in areas like retail and hospitality, which means, you know, shops and restaurants and cafes in pubs and hotels. And of course, all of those, you know, have struggled over the last 80 months and face challenges going forward. So I would still invest in all of those sectors, but I’ve also made an e-commerce investment last year into a gardening products business it’s called Primrose. And that has an October year end, but we think it’s gonna deliver for this year’s results because it’s had the principal season now and we’re happy with that purchase. We bought it almost a year ago now. And I think it’s a good sector. And I think eCommerce in that space is growing gardening itself has boomed during lockdowns. And I think some of that will stick. And we are looking at further eCommerce investment because obviously it’s gonna take an increasing part of the market in terms of people’s overall retail spend. So

Ross Butler:

What’s primroses model. Do, do you have to go onto their website to buy their stuff or do they start.

Luke Johnson:

Yeah. I mean, you know, they have an app and so forth too, but mostly people are on the website and, you know, it’s, it’s exclusively, it’s not an omnichannel, so it doesn’t have any retail outlets at all. It only it’s, you know, only digital, and it’s quite long established business. And, it’s quite a fragmented sector. Actually. There are quite a number of digital players in, the overall gardening space. You know, it’s a sector that we stumbled across, but we like, and, I think there’s more to go for. So, yeah, I would say that was, a deal that we’re excited about and we think has, has lots of potential. And, and so inevitably, you know, if you look at e-commerce generally, you know, you are up against Amazon, but there are some sectors that they are perhaps less focused on. And I think gardening, you know, has some logistical challenges, gardening, for example, that Amazon seem less interested in. Right. And they’re such dominant player, ideally, you know, you don’t wanna be directly competing with them. Mm. We do work them actually as most people do in e-commerce, but, ideally you get people on your own website. Yes. And so yeah, that’s one business we’ve bought recently that, we think is interesting.

Ross Butler:

Great Luke. Well, it’s been great catching up with you in person. Thanks very much for sparing your time.

Luke Johnson:

Thank you.

Ross Butler:

You’ve been listening to the fund shack podcast, make sure you subscribe and visit our website@fundshack.com for many more video interviews. It’s the private capital channel for alternative investment professionals. Thanks for listening.

Alistair Lester, CEO of Aon M&A on protecting and enhancing returns

Fund Shack
Fund Shack
Alistair Lester, CEO of Aon M&A on protecting and enhancing returns
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Alistair Lester is CEO of Aon’s M&A and transactions services business in EMEA. This is not the conversation you think. Aon has spent recent years building out its capabilities across the risk spectrum.

Or watch the video version here.

 

Transcript

Ross Butler:

Alistair, you are the CEO of Aon’s M&A business in EMEA, but it’s not your first bout there. You started in the graduate scheme some 25 years ago, and in the mid 90s working for private equity clients. And I wanted to start by asking you to what extent has the insurance services industry over that quite long timeframe responded to the pace of change in the world and the risks that businesses and private equity firms face today?

Alistair Lester:

There’s been a huge amount of change of course, in the world. The insurance industry is not renowned for being particularly speedy in terms of pace of change, but actually there’s been a pretty significant amount of change within the insurance industry and particularly within the part of the insurance industry and the broader professional services aspects of our world that faces off to the M&A and private equity ecosystem. When I think back to being told that what we did for private equity firms was a niche part of our industry and a niche part of a firm that I previously worked for.

Alistair Lester:

I think we, as an industry, are really only just starting to embrace the scale of that relationship opportunity in the same way in the last three, four, five years, a couple of good examples of what’s really driven that Ross. If you go back two, three years, if I said to a PE firm, what do you think of Aon, Aon could do to help you? They might say, I know you, we talked to you on the limited partner side, you’ve got a big investment management arm of your business, and we talked to them about LP investments, or you are an LP in our fund or, or they might likely have said insurance due diligence. And they might’ve said something more recently, this warranty and indemnity insurance, or as we call it in the US, reps and warranties insurance product,  which has genuinely exploded in the last four to five years in utilization in PE.

Alistair Lester:

And yes,  we do all of those things, but what’s really exciting for us is our ability over the last few years as our industries evolve, and as Aon has evolved to bring multiple advisory capabilities, multiple advisory work streams to life on the one hand and multiple or an increased number of financially motivated insurance instruments to bear on the other hand and much more sophistication and science around how we really do develop, deliver value in the portfolio. So when you have that conversation now with clients who’ve been on that journey over the last three, four years, they would absolutely recognize our industry. And particularly our firm, I think, has been leading the charge in areas like cyber consulting, in intellectual property consulting and advisory and valuation, of course, in risk and assurance in the broad set of human capital from retirement benefits, but also talent reward and compensation aspects of deals.

Alistair Lester:

Then on the instrument side, looking at the adjacencies to warranty, and indemnity insurance like loan contingent risk insurance, be that tax insurance be that litigation insurance we’ve pioneered a product called judgment preservation insurance. We’ve pioneered the ability to wrap insurance around your intangible assets or intellectual property. You can potentially use those instruments as collateral, which enable you then to access different forms of financing. So really the big change has been this institutional-industrial realization there is an opportunity to marry up what has traditionally been seen as a relatively lazy, perhaps enormous pool of insurance capital with all the parts of the capital markets and bridge the two in a way that drives value into private equity deals, because as you and I both know, private equity are just so hungry for what they call new technology and new ideas, and that’s been a fantastic accelerator for what we do.

Ross Butler:

Why is AON providing the services that it is providing? What’s the journey from your insurance services capabilities to the services that you’ve currently  just outlined?

Alistair Lester:

The world lives in a world of risk, and Aon as a firm is all about risk. We are a risk business. Insurance is an instrument that can help clients manage their risk. But what we don’t do is just deliver insurance products. We also deliver a range of advisory capabilities that help clients understand, identify and mitigate risk insurance instruments are just one part of the mitigation aspects of how you deal with risk. Every deal that any client does, they price risk into their deal, and they deal with risk in a deal in different ways. Maybe they priced chips. Price chips are a result of people identifying risks they’re not comfortable with. Maybe they seek contractual recourse against the seller against the counterparty, and maybe that contractual recourse is somehow secured through escrows. Maybe, as a buyer, if I identify risk in a deal, I defer an element of the consideration to see if that risk crystallizes, and if it does, I’ve protected myself because I’m not having to pay my deferred element of the consideration. All of those things are well-established approaches to dealing with risk in a deal. Those risks need to be identified for people to be able to understand them and then come up with solutions for them. So, the exciting point is we think those three buckets of price-chipping contractual recourse, and deferred consideration, they’re all perfectly valid ways of dealing with it, but none of them are actually optimal ways of dealing with risk in a transaction. By contrast, optimal approaches can include solving them through more insight into those issues, so you get more comfort with them. We can provide that in a range of ways across people, risk and cyber risk and intellectual property risk, et cetera, et cetera. But secondly, by introducing an insurance instrument, which can take that risk away in a far more attractive way and deal with those potential risks in a far more attractive way, potentially than price chipping or deferring, or getting contractual recourse against the counterparty.

Ross Butler:

And all of this kind of moves you further towards, I suppose, insurance being a purely defensive product. You’ve got a clear line of sight to enhancing returns through all of this.

Alistair Lester:

You’ve teed it up beautifully. So, we talk about what we do is securing investments and enhancing returns. That is our little strapline. We think with our advisory capabilities, we can give you much more insight into what you’re getting into. We think with some of the core traditional insurance solutions that are out there, very plain vanilla, traditional insurance solutions, you can secure that investment. But actually going to your point on enhancing returns, we think that we are able to deliver these structured insurance instruments across a wide range of areas, including structured credit and tax and litigation, et cetera, whereby spending a pound, a dollar or a Euro on that instrument you are realizing or recognizing multiples of that either in the enterprise value or somewhere in the capital structure of the transaction.

Alistair Lester:

That is a very different way to think about insurance, where for most of us, including people who live and breathe it, you know, renewing our car insurance or home insurance, or even our business insurance every year, what you’re really looking for is a way of reducing the cost of insurance, because you see it as a sunk cost. You don’t see it as a return generating instrument, whereas with a lot of what we’re doing, it’s spend a dollar or Euro pound on that instrument, and you will see a multiple of that somewhere in your enterprise value or capital structure.

Ross Butler:

It seems to me that risks over the, say, that 25 year period, have gone from being relatively tangible, relatively geographically, constrained to being much more intangible, much more distributed across the world, less physical and therefore just much more complex. And I suppose, as a result of that, harder to quantify and I guess where there’s complexity there is opportunity, which is why it’s logical for insurance providers to have expanded in this way. Is that a reasonable reading?

Alistair Lester:

I think that’s, that’s a very astute reading Ross. I think this is why Aon has diversified its capability set, for exactly those reasons, And if you double-click on intellectual property, as an example, and intangible assets, as an example, you only have to look at the huge rotation of the S&P500 over the last 40 years, which has gone from being, completely dominated by hard assets, tangible asset values, and companies who operated in those areas to companies, which are absolutely intangible asset rich and intellectual property based. And as a result, by the way, the insurance industry, some argue, has struggled to stay relevant as it could have done growth of global insurance premiums has lagged global GDP growth for that reason, because the insurance products are not as relevant as they need to be to what’s going on in the world traditionally. So, Aon made a move into intellectual property – and this is what Aon has done brilliantly – we have purchased capability and talent in adjacent areas to us. So, we bought a business, which was one of the leading intellectual property consulting businesses. And then what we’ve done is we have worked with that business to deploy that capability into a private equity context. We’ve worked with that business to build insurance instruments that can deal with intangible risk and intangible assets in a way that wasn’t previously being addressed. And we’ve gone one step further by helping to use both of those things, the insights and the capability we have on the advisory side, the risk modeling, the quants capability we have on the valuation side to then build product, which is enabling and opening the door to IP, rich companies, to access financing, using insurance as a collateral around their intellectual property in a way that’s never been possible before.

Alistair Lester:

So that’s an absolutely spot on. What Aon has done over the last five to ten years is it’s added inorganically areas of talent and capability, whether it’s in cyber, whether it’s in intellectual property, the talent world, we’ve added businesses and people who have bought different skill sets to our firm. Many of whom have had zero exposure to the insurance industry before. But actually by bringing these people into our industry, they are giving us perspectives on different emerging risks, which we’re able to support clients from an advisory point of view with, but also match those risks into the huge pool of insurance capital and start to build some new and evolved and developing insurance solutions that, that provide answers.

Ross Butler:

Tell me a little bit more about the, the IP services, in the specific context of venture capital and private equity. What type of business is it most useful for?

Alistair Lester:

So we think that one of the things we’re most excited about is we’ve always had a relatively limited story for the VC end of the private equity and financial sponsor community that is truly value added. We have an ability to identify, map and value the unique intellectual property, particularly the patents, but not just the patents, it can be data. It can be trade secrets, et cetera of individual companies. By doing so, we place a value on that, on that intellectual property, through a proprietary valuation methodology. We have the former head of intellectual property at Phillips in the Netherlands, global head of IP at Phillips. We have the former general accountants of general counsel for patents from Microsoft, right. People who honestly, if you ask them, ‘Would you ever, five years ago, can you ever see yourself working at Aon?’ They would have said, ‘absolutely not. Why would I?’ So we have some unbelievably deep talent in the IP space. I think we have more of the top 300 recognized global IP strategists working for Aon than there are at any other company in the world. And no one would know that right.

Alistair Lester:

We then spent a long time persuading the insurance industry of the efficacy of that valuation methodology, and there are many other parts of the capital market’s ecosystem, which rely on the underlying security of insurance to enable financing. We look in the aircraft, leasing space, residual value insurance on aircraft hall is, is a critical requirement for aircraft leasing. You know, finance use of aircraft leasing require certainty over what the, the aircraft may be worth at the end of the 10 year lease. And the way they’ve got that in the past is through residual value insurance that provides the underlying security, really what we’re doing and intellectual property is a similar thesis. We are valuing the intellectual property for a proprietary methodology. We then were demonstrating the efficacy of that valuation to the insurance market who are then wrapping an insurance policy around that value, not at a hundred cents on the dollar at a discount to the value, maybe 50 cents on the dollar by wrapping insurance security around what were previously intangible assets.

Alistair Lester:

You are turning them into tangible collateral. And what can you do with tangible collateral is you could raise finance against it. So, now we think we’re inventing or pioneering at least a new potential way for firms who are in the maybe series B series C stage to raise working capital and runway capital. Because up until today, the primary way for those firms to raise money has been to raise equity founders that owners don’t like raising equity, it’s diluted, it’s expensive, it’s painful all of those things and actually being able to, or they go and raise venture debt. And venture debt performs an essential service, but also it’s not, it’s got a lot of complexity to it. We think we have an instrument now, which can enable you to access pretty straightforward, not cheap, but pretty straightforward debt secured against an insurance wrapper, which is wrapping your intangible assets. And we think by doing that, we are potentially reinventing how you finance early stage companies. The British Business Bank wrote a paper probably two years ago saying why can’t banks recognize intangible assets more as collateral for financing? We think we are leading the answer to that question, which is- what can you do if you do it in this particular way?

Ross Butler:

I assume that larger businesses with large IP people folio, they’ve got other financing options.

Alistair Lester:

A hundred percent. That’s a great question. But, and yet, we also have clients who are approaching us and asking whether we can collateralize their IP portfolio for the purposes of satisfying pension trustees. Right. For example. So, you know, we need to provide collateral to our pension trustees. Maybe this is a product that we could use to satisfy our pension trustees over pension liabilities and future pension contributions. We’ve got financial institutions who are approaching us and asking whether this is a product that they could use to satisfy some regulatory capital requirements, right. So, you know, is this a product that could satisfy the banking regulators to a certain level that intellectual previously unrecognized intellectual property that they held in their business is now something they can collateralize and use to enhance their financing of, of whatever obligations they have. So it isn’t just the venture answer, but we’re seeing particular appetite and interest in the venture backed community in the early stage businesses area at the moment.

Ross Butler:

That’s a great example of allowing people to focus on the upside and enhance their returns. I don’t want to spend the whole time talking about COVID, but obviously it’s completely changed the nature of, and scale of risk. That touches on so many parts of business, so I’m thinking particularly like cyber, for example. I was speaking to a CEO the other day, he’s based in London, 90% of his employees are in India. Geographically remote. Can’t get out to them very easily. All of these risks seem to be not really thought of, just a couple of years ago.

Alistair Lester:

We launched our cyber- M&A private equity focused business, getting on for two years ago now. We did it for a couple of reasons. Outside of private equity and M&A, Aon had made an inorganic acquisition in a company called Strauss Frieberg, which was one of the leading global cyber risk consultancies that grew up in the US and again, I I’d imagine if you spoke to many of the people inside the original business, they had not had anything to do with the cyber insurance worlds. They were deep cyber risk consulting people. Then we built a client facing delivery of some of the capabilities within that business, and we did that by, we actually bought across people from the big four who were providing private equity, cyber due diligence, which was just emerging two or three years ago. We bought some of those people across. And the exciting thing is, we were able to persuade them of a couple of things, which I think we’ve proven out, which is one. We have the in-house technical cyber capability that we just bought this business with deep technical cyber risk capability. But two, we also have in our industry, a huge amount of data insight from cyber insurance. So we know what is happening in the cyber risk world, because cyber insurers are paying claims for our clients. So we know what’s, what’s creating those claims and we know how much is being paid for those claims and how those claims are being managed and how the risk of being mitigated to avoid them happening.

Alistair Lester:

Again, you put together deep cyber technical expertise with quant data, true deep, rich data over what is actually going on in the cyber world, which is causing financial loss. And you’ve got a unique skillset. So, our cyber team, actually very specific to private equity, have built something called Portfolio Scanner, a piece of proprietary tech, which blends in automated threat analysis with a quant model. We’ve done this for a number of PE firms. You can run it at relatively low cost, to come and run a six month cyber review across your portfolio. You can run it in very quick time, automatically across your entire portfolio, and it gives you a traffic light outfits of which firms in your portfolio need a closer, deeper dive from a cyber risk point of view.

Alistair Lester:

It’s no guarantee that there’s no problems in the ones that are green or amber, but it will tell you from an outside-in point of view, an unobtrusive outside-in points of view, where we think based on outside threat and industry sector knowledge and claims statistics from cyber insurance, you should be going to look Mr. GP to double-check that firm is doing what it should be around cyber risk. We actually ran that for a GP last year. And one of the firms that came out on the red of the traffic lights, we literally just reported to the sponsor. And just 10 days later, as we were going through the action plan, they had a ransomware attack. And that led into a huge recovery exercise. Again, no guarantee that if we ran that exercise six months earlier, the ransomware attack wouldn’t have happened, but certainly there would have been more awareness within that firm of the risks and, and hopefully some, some mitigating actions would have been taken.

New Speaker:

What’s really powerful areas that is all consulting work, but we’re delivering technical and rich data insight in an, in an automated manner, in a highly efficient manner, real time. We are launching and delivering within three to four weeks, not let’s run a long cyber risk consulting project, which takes many months because by the time the speed of the world’s changing so much that, you know, six, nine months’ time, it’s a different threat. It’s a different group of people. It’s a different type of ransomware, whatever it is, you know, you need to be keeping on top of this on a regular basis.

Alistair Lester:

So a lot of our PE funds now are actually running Portfolio Scanner on a regular basis, but at six months or 12 monthly, and they run it, it’s just a, it’s a health check across their portfolio. And it just helps them stay in touch with, with exactly what’s going on. And, you know, we were quite excited. We ran it for Cinven, which reported that in their ESG report.

Ross Butler:

That makes perfect sense to me, marrying the qualitative in the quantitative. I’ve long felt that you have the cyber professionals who are focused on best practice and process, but you’ve also got the kind of the unknown quantitative part, which is the elephant in the room. And you know, companies that pay ransoms, they don’t publicize it, of course. And one suspects that it is a much, much bigger problem than most people realize had they had to send a press release out and it was in the media. And so there’s something of a disconnect between the scale of the problem and what to do about it. And it sounds like you’re able to contextualize the problem and then find the solution, which feels to me like where I’d want to be.

Alistair Lester:

Yeah. Yeah. Look, I think just one thing I’d add is, is I’ve just talked about that in a portfolio context, which is critical. The other thing we’re learning is fascinating is our clients who go through that exercise, looking inside the portfolio, across the portfolio, they almost without fail, ensure they implement pre-investment cyber due diligence as a specific work stream going forward. A lot of firms haven’t been. Or they felt that their IT DD covers cyber. They’re close cousins, but they are distinctly different things. By the way, we’ve also got to make sure we’re okay as we’re going into new deals and this whole workstream of cyber due diligence, which we think where that evolving further into what we call digital and tech DD, where you’re looking at yes, the cyber risks.

We had a client say to us not long ago, every deal is now a tech deal, right. So let’s look at the tech in that business and understand how risk-exposed it is. We just brought a guy in from Turner & Townsend, a well-respected property consultants. Again, not an insurance guy, he’s a risk consulting person, but he’s able now to deliver his risk advice in a much more informed and contextual way because of the data and the insights we can provide from inside the industry. And that’s why we’re bridging the advisory and the risk transfer together.

Ross Butler:

So just so I’ve got the lexicon straight, you’ve got it, diligence, which is like you, your internal systems, and processes, and making sure that they’re efficient and functioning. You’ve got cyber, which is like security and stopping attacks. And you’ve got digital and tech, which is

Alistair Lester:

It’s performance risk. We ran a deal for a PE fund who was buying a, a reasonably well-known real estate platform. Right. And actually what we helped them understand was how many of the hits on the platform were from bots and how many were genuinely from independent consumers, right. And that goes to value. You want to pay for the consumer. So it starts to become not just a risk issue, but also evaluation issue, which is exciting.

Ross Butler:

What about people risk? Do you do anything in that domain? Obviously there’s a link with, with cyber and behavioral behaviors.

Alistair Lester:

We do it very broadly. And I think traditionally again, when people thought, well, what would Aon do in the human capital space to help us? It would be, well, we’ll do some actuarial work on the pension plan, or we’ll do some look at life and medical insurance and make sure that we’re meeting employee benefit risk. But again, Aon bought a business not long ago called QT, now rebranded Aon Assessment Solutions, they are a bunch of psychiatrists and psychologists. We had an infrastructure client who was funds, who was buying a, a bus business. I mean, lots of infrastructure funds by bus businesses. I think EQT had just bought a big one in the US.

New Speaker:

Interesting little story: we were arranging motor insurance for the bus company and they have to have it. And one of the things that drives motor insurance is, is driver’s safety. The price of motor insurance is driven by how safely, how well do you train your drivers. We brought in our Aon assessment colleagues to create a framework for the type of personality that they wanted to hire and to maintain as bus drivers and to put it very crudely, you are looking for people who are less aggressive on the accelerator, on the gas pedal. There are characteristics which are going to lend you to be more heavy or less heavy on the gas pedal. So that had two incredible benefits.

Alistair Lester:

One: By doing that, and by demonstrating to the insurance company that they were hiring that sort of person that puts the risk in a better light, it enables Aon to secure a better price for the core old-fashioned motor insurance for the buses. But here’s the other thing you could also demonstrate: how the fuel consumption of the fleet would reduce and the environmental positive environmental impacts. And of course, the economic positive impact in terms of reduced gas fields and fuel bills for the bus fleet. You’re going to value in way more ways than just one, which is we can help you reduce your insurance premium. We could also help you reduce your operating costs through reduction of fuel consumption, and we can demonstrate that you’re thinking about that through an ESG lens in a world where those things are increasingly important. It’s a really good example of how we’ve gone from being an insurance broker to adding these other elements to a value.

Ross Butler:

And that comes from presumably the psychological profiling of the people

Alistair Lester:

Right. So when you go and hire now bus company, you need to hire people with these characteristics, which we have defined for you, and it’s now built into your, your recruitment processes.

Ross Butler:

There’s a huge change that’s, that’s happening in terms of the work environment. Are you’re doing some thinking on this area.

Alistair Lester:

So again, we have an enormous human capital practice who stretch right across, you know, governance, board consulting, compensation, talent, et cetera. And, and we have, we’re one of the firms we sponsored in various countries, something called the Work Travel convene. So we brought together in Australia, in the US and the UK in different countries, large employers. And we’ve done that over the last 12 months. And this isn’t, you know, the private equity and M&A world, but this is more broadly as Aon. And what we tried to do in the private equity community is then bring the conclusions and the insights that, that are being created from those sort of exercises into P funds into their portfolio. But the work travel convene is really trying to look in that crystal ball about where this is going, what are the implications for the workforce?

Alistair Lester:

One of our big areas of course, is terms and conditions of employment and benefit packages, and how do you construct compensation packages to reflect different working environments and all of those sorts of things. So a huge amount of work in progress on that. And I think a lot of clients are increasingly looking for help in that area, because as you say, there’s so much uncertainty.

Ross Butler:

Yeah. I think also private equity firms are increasingly focusing on people and talent and talent retention is their core asset. And you’ve got private equity firms hiring HR, internal HR people to just think about that within the portfolio.

Alistair Lester:

Again, one thing that people won’t know probably is Aon has two businesses, one called Radford, and one called McLagan. They are two leading compensation consulting and compensation data businesses. In fact, McLagan is probably recognized in the general partner and the, in the PE community as being the leading private equity compensation consultant in the world. We know we build many of the, many of the maps, many of the GP carry plans, they come through McLagan insight, but again, Aon in the past culturally McLagan would have been run as a very independent business, delivering his value to its clients in a, in a slightly isolated way.

Alistair Lester:

The way that the firm has been reorganized in the last few years is, is around what we call Aon United which is really about bringing the whole of the firms and the clients, and the fact that we have people who are delivering compensation and talent advice to a large number of PE funds, you then think about how can you maximize compensation particularly through carry of your general partner practitioners through the ever-increasing adoption of innovative solutions and innovative financing structures, right? So those things are linked as well. We can help you maximize returns in your portfolio companies, which then drive your compensation structure that we’ve helped you put in place by the way, through these ideas over here. So, these things are not all individually separate from each other. They are all intertwined.

Ross Butler:

I’ve got a couple of other COVID things on my list. Supply chains, which I assume is bread and butter for insurance services, but global supply chains, given international relations and protectionism, is, it’s not in a good place.

Alistair Lester:

That’s a critical factor. One of the most important parts of the insurance world, which is probably overlooked is two areas, but one is business interruption insurance. That’s come under the real spotlight as a result of COVID. I mean, let’s be honest and, and not necessarily the most positive spotlights, and we’ll see how that all plays out, hopefully positively for policy holders who have valid claims. People in our industry have been talking about supply chain risk for a long time. I think what COVID has done is accelerate that and now there really are needs for firms to really, truly understand their supply chain, but not just because of the, the revenue and the, and the financial risks, but also increasingly through an ESG lens as well, you know, modern slavery background checking, all of these sorts of things are really important in the supply chain.

Ross Butler:

I’ve written a couple of things down from your preamble, but I can’t quite read my writing. Judgment preservation insurance. Is that right? Yeah.

Alistair Lester:

So that’s a, that’s a new area we’ve developed over the last year or so. So we’ve invested heavily in, in our litigation risk group. So there again, there is a theory, a thesis that we would like clients to see litigation as a potential asset, rather than just something they unfortunately have to go through. If you’re bringing a claim against somebody and you believe you’re going to win. And more than that, perhaps you’ve won at the first quarter or the second court. We developed a product which will enable you to ensure as much of that judgment as you can. And in the event that it progresses to the next layer and you lose, then the insurance, it provides you that, that capital. And here’s the thing that that’s really exciting. So we just closed the deal for a client who had won a significant judgment against the large US firm. And we were able to secure several hundred million dollars of insurance, which by the way, it was not the total amount of the judgment award. It was a substantial tranche of it, but by no means a majority, we were able to secure some, several hundred million dollars in judgment preservation insurance, which very simply said in the event that this is overturned, you are going to be indemnified by the insurance company, and that’s nice to have, right. But here’s the really positive and interesting thing: that firm was then able to use the judgment preservation insurance to access third party financing. So the insurance became collateral to access financing. Litigation funding has become a big thing, right? Litigation financing has been around a long time. It’s absolutely got a place. It provides a very essential service. But we are introducing new ideas, which potentially are alternatives to that, arguably again at a lower cost of capital. And that’s super exciting. We’ve hired people in our firm from litigation, funders and litigators who understand that world. And what we’re really doing is using their knowledge and insight with our capability of building insurance, structured insurance instruments and structured products to, to redefine how, how clients can, can see, find value in those sort of situations and see them as assets.

Ross Butler:

In a private equity context, every moment counts, it’s the distraction, I would imagine more than anything, you don’t want it as a standing board item, when you’re trying to grow a business fast.

Alistair Lester:

This is exactly right. And certainly when you come into exit, right, what you do not want is uncertainty over litigation and exit. So we do a significant amount of wrapping up litigation like we do within the tax world. What insurance is very good at Ross is, is rapping, is bridging low probability, but high financial risk situations into certainty, right? And of course that costs money, which is the premium. But that’s what insurance can be very good at. And if you can, you can do that increasingly with tax. Some brilliant advisors around the world will tell clients, this should be fine. What you get from the big four, what you get from the lawyers is we’ve done this before. This should be fine. What you don’t know is whether someone on the other side of the deal table to you has the same view.

Alistair Lester:

Maybe they are a large conservative, strategic, maybe it’s the first time they’ve done a deal in that jurisdiction, whatever their motivations are for feeding the risk, the perception of the risk is different to your perception of a risk. And those are the sorts of things that can derail deals, right? They can get, they can, they, you know, they, they become distractions from actually, this is fundamentally a good business. We want to buy here, but we’re getting distracted by negotiating and arguing over whether we think this one piece of litigation is more or less likely to happen or more or less likely to cost this amount of money, right, and insurance can deal with those situations by giving you a well, we can sell you, it will cost you this to take this issue away. Now, all of that cost makes sense in the context of the data.

Alistair Lester:

It doesn’t, but at least it gives you something, a point of certainty, which you can get a resolution on and that’s becoming much more understood and that’s relevant in tax too. And you can push further by the way, without getting too off piece into further adjacencies around structured credit. So the same broad thesis Ross applies in receivables financing. So one of the things COVID has done is really drive a real increase in the amount of receivables financing that go on in the market. What many don’t appreciate is if you can wrap insurance around those receivables in an appropriate manner, you can de-risk that portfolio receivables. If you’re de-risking that portfolio of receivables, you can arguably lengthen the tenor and reduce the coupon on the financing terms you’ve got. So it’s the same thesis. And just in a slightly different situation.

Ross Butler:

So do you have a classic CEO 3 or 5 year vision for Aon in M&A?

Alistair Lester:

I do. We’re living in the middle of the hottest market we’ve seen in, in a long time. We’ll see how long that lasts. But I think, I still think we’re scratching the surface in terms of the value we can bring to our clients. If I’m really harsh on ourselves, we still are delivering one or two of our core traditional value propositions into a deal. And actually if we just paused and, and delved a little deeper into the deal or had the right conversation in the right way at the right time, there are multiple live opportunities that we have allowed our clients to leave value on the table because we haven’t been either able to identify or able to articulate how we could find a way to help them to, to find that value and bring that value off the table. So that’s really the key thing. I think we’ve grown enormously in the last three to four years. There is still huge white space for us, we think because there’s just, we’re very fortunate. We’ve got an incredible breadth of services and we’re backed up by this incredible ability to bring capital, to bear in a way which hasn’t happened before. And honestly, we’re scratching the surface.

Ross Butler:

Alistair, thanks so much for your thoughts and for coming on to Fund Shack. 

 

Alistair Lester:

Listen, thank you so much for having us Ross. It’s been great.

 

Dan Aylott

Dan Aylott, Cambridge Associates

Fund Shack
Fund Shack
Dan Aylott, Cambridge Associates
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Subscribe on Apple Podcasts | Spotify 

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.

Alternatively, you can listen to the filmed version here.

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.

 

Cyril Demaria

Cyril Demaria on Asset allocation and private markets

Fund Shack
Fund Shack
Cyril Demaria on Asset allocation and private markets
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Cyril Demaria is a leading private equity thinker, fund investor, and affiliate professor at EDHEC. He is the author of numerous books on alternative investment, most recently co-authoring Asset Allocation and Private Markets (March 2021).

This is a Fund Shack ‘private chat’ about the difficulties of reconciling a liquid with an illiquid investment programme, and how institutional investors can begin to reconcile these two investments universes.

Check out his earlier conversation on ESG, here.

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