October 26, 2015
Interviewed by: Tom Franco
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ADIA’s Kester on a Career Building Portfolios

The former head of private equity at Abu Dhabi Investment Authority, James Kester, gives an overview of the path that led him to one of the largest investors in the world, and details the art and science of PE portfolio construction, as well as his recommendation for entering the asset class from scratch.

The former head of private equity at Abu Dhabi Investment Authority, James Kester, gives an overview of the path that led him to one of the largest investors in the world, and details the art and science of PE portfolio construction, as well as his recommendation for entering the asset class from scratch.

ADIA’s Kester on a Career Building Portfolios
With Jim Kester, Former Head of PE at Abu Dhabi Investment Authority

Dan Feder, Washington University Investment Management Co.:  I’m here with Jim Kester this afternoon. Jim, you have an interesting background in working with some very large pools of capital. I’m wondering if you could provide a bit of background of the groups you’ve worked with in the past.

Jim Kester, Abu Dhabi Investment Authority: I’d like to describe my career as bifurcated. In the first half of my career, I worked at operating companies, for operating companies—some very large, some very small. I started by career at General Electric. I also worked for General Motors for a time, and, at one point in my career, I started a company and helped other entrepreneurs build their companies. The second half of my career, for the last 15 years, I’ve had the privilege of working for and leading the private equity units for some large global institutional investors—initially Alliance, in both Munich as well as New York, then Zurich Financial Services and, most recently, with Abu Dhabi Investment Authority in the Middle East.

Feder: You’ve had fairly deep experience building programs. One of the things I’d really be interested in hearing about is, when you’re building a program around private markets, strategies, you don’t know whether you’ve done a good job. And nobody will know whether you’ve done a good job for five, six, seven or eight years down the road. Even then, it may be hard to decipher whether the portfolio’s doing what you want it to do. That’s all fairly uncomfortable and, as you’ve gone about building programs, how have you worked to get governance right in a way that allows you the ability to build something that there’s not immediate visibility on, whether it’s working or not?

Kester: It’s a very good question and one of the conundrums in our industry, I suppose. At its core, one needs to communicate well with whoever’s capital one is investing and whatever governance structure one is investing under. It really depends on the institution as to whether that is one or several parties. I’ve had a variety of different experiences there. At Alliance, we were essentially an independent unit wholly owned by Alliance, within

the group, and we needed to contract with all the different balance sheets, one-off negotiations, each time to manage their capital and then report to them in a way that you…or an independent investment manager would report to their client.

At Zurich, it was much more streamlined. My experience at ADIA was also very streamlined. We had one investment committee. We had an investment committee at the department level, but ADIA has an investment committee that oversees all the investment decisions across all of the investing units that has ultimate investment decision authority.

Feder: As you’re going through years one, two, three, four and five, are there metrics or ways of communicating progress that have been particularly effective at answering the question of how’s it going, how are we doing?

Kester: Again, I think it’s a bit about educating, setting expectations and communicating regularly. Those would be the three principles that I would suggest people adhere to. Again, the objectives of the different investors I have worked for have been completely different. As European insurers, their objectives may be different from U.S. insurers. So, our U.S. clients might have more current income objectives because of the way their investment accounting and accounting works in terms of operating profit versus our European investors all within the same group.

Feder: Maybe switching gears a bit in identifying managers: how important or how useful is it to find new teams to back and be a founding investor with those teams, particularly if you have a fairly large pool of capital to manager and where you want to leverage relationships, I would think?

Kester: I think there’s a conundrum for very large investors to do that in an appropriate and meaningful way. But I have managed portfolios that have been of a size that would permit doing that. And when I look at my own track record, the first-time funds I’ve underwritten—and there have been about five—as a group have outperformed the broader group of managers that I’ve underwritten for clients. With a greater dispersion of returns, but as a group, meaningfully better. Then, I’ve backed another set of managers with what I would call “first institutional funds”—they had a small pool of capital prior. As well, the returns on that group of investments are also substantially above the average of my underwriting.

I think it has an extraordinary number of additional benefits in terms of being an early supporter of a manager who’s raising their first fund. That’s not even being a sponsor, if you will, where there may be additional economics attached to doing so. That is an interesting strategy, and there are people out there that do that exclusively and explicitly. The difficulty there is that, if everything comes attached with a requirement to have a stake in the GP and potentially the management company, there’s a self-selection problem that one needs to be aware of.

We live in a cyclical world and there’s nothing worse than starting off your portfolio at the market highs. But if we speak alternatives, then we bring into the mix private equity private debt—private equity, including venture capital, real estate, infrastructure, real assets—and then we play with a variety of different cycles.

In the private markets, specifically in private equity, presuming that you haven’t taken a very aggressive approach and that you are looking to invest strictly directly in the private markets—there are certain investors that take that approach but I find them typically to be more family office-oriented than institutional investor-oriented. So, if you are going to have a significant portion of your portfolio managed by outside managers, third-party managers, entering the private equity market through a series of blind-pool fund commitments will create a significant J-curve in your performance. And many people would not want that.

Entering the private equity market with a large secondary position is an advised way to establish a base. At the same time, that can be done with relatively few resources, well advised by external advisors and then building a team on top of that to—again, depending on the portion of your portfolio you want to be investing indirectly versus directly and when I say directly, I mean with an active co-investing, co-sponsoring approach. That takes a greater deal of time to build an appropriate team and to develop an appropriate strategy.

Case in point, ADIA had a significant portfolio when I joined. And in fact, was…quite a bit out of balance between the portfolio—the size of the portfolio, the number of positions in the portfolio and the size and capabilities of the team—that needed to be rectified. And even though the bulk of the portfolio was indirect, our strategy was to invest greater amounts of capital going forward directly. The benefits of investing directly—and when we say directly, ADIA was not in the sole control of their investing business, nor even in the joint sponsorship business. There were

both tax limitations as well as disclosure limitations on the size and the positions and the percentage of a company’s equity that we would take.

But, what we were building was a team that was capable of doing its own underwriting, or underwriting in conjunction with a co-sponsor, paying our own fees and expenses, pricing securities, holding securities directly and governing commensurate with our equity ownership—all of the attributes of being an active equity investment partner.

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