April 29, 2014
Interviewed by: Tom Franco
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Adveq: Private Equity The World Over

Lee Gardella of Adveq discusses the state of private equity in Europe, the firm’s insights into venture capital, and assessing emerging and frontier markets.

Lee Gardella of Adveq discusses the state of private equity in Europe, the firm’s insights into venture capital, and assessing emerging and frontier markets.

Private Equity The World Over

With Lee Gardella of Adveq

Franco: We’re here today with Lee Gardella from Adveq to examine private equity from a global perspective. Lee, you travel around the world talking to your clients, and it’s an uncertain economic environment with a fair amount of volatility. What’s the case for private equity in that context?

Gardella: Good morning, Tom. It is clearly on topic for our clients—how you deal with uncertainty in the marketplaces, particularly when you’re allocating to an illiquid asset class like private equity. We’ve been able to show through independent research and our experience that private equity has clear benefits and clearly adds benefits to their portfolios.

Private equity has not been nearly as volatile as public exposures and it has obviously inherited some valuation methodologies. But really, within the core of private equity—the ability to influence direction of the asset, the investment, and express a value orientation to your investment activity—our clients can create value for their portfolios beyond their equity exposures in both marketplaces. We think it is a fundamental part of any equity allocation on a global basis, without a doubt. It supports itself through its performance as well as its risk profile.

Franco: When you think about economic uncertainty today, Europe is top of mind. What is your take on the European private equity environment?

Gardella: I spend most of my time traveling the States, but I go to Europe, where we’re based, and Asia, where we have quite a bit of activity and client activity. We are not as threatened nor do we fear the European situation as the American institutions perceive it to be. It’s been a great benefit to have that perspective for us.

There’s been a consensus at one point here in the States that the Euro was going to go away. We always felt confident the Euro was going to be in place and we took advantage of that for our clients. You can see it in our European portfolios. As the European economy begins to recover, and we’re seeing early signs of that, we expect our existing exposures to benefit.

Franco: Adveq is recognized for its insights around venture capital, mainly due to its origin. What is the role of venture capital in the institutional portfolio today?

Gardella: It’s challenging. The attributes of venture capital present a challenging execution story for your average institution. Without a long track record about relationships and without raw data, it’s hard to tackle venture capital.

Clearly, over the long run, venture capital has proven to be accretive if you do a good job at it, but there are scars along the way—a lot of pitfalls people run into. This past decade was tough for venture capital, but we have seen in the last few years that the sins of the early 2000s have mostly gone away, and venture has been robust. We see it directly in our portfolio—actually the most historical part of our business. We’re in a fund seven in venture capital. It is an area that has been very robust for us.

But you have to be able to look forward, which has to be research-driven. I find the average investor tends to be looking backward on whom the brands of yesterday are. That’s one way of looking at it, but we’re trying to identify who’s going to execute tomorrow. Venture capital can be a part of a portfolio if you have the resources and the legacy and the experience behind it.

Franco: Forward-thinking and having plenty of experience. Another area where I’d like to get your view is co-investment, which has become quite popular, both with large and small institutions. What do you think about this trend? What should we be thinking about, in terms of risk management?

Gardella: Co-investment is clearly top of mind with virtually all investors in private equity today, either in aspiration or in execution. The success rate is probably undetermined today. People speak to trying to get more capital to work quicker and we’re lowering fees. Our preference is that it’s only to drive additional return. It provides less blind-pool risk for us as an investor. That is the sole reason we pursue co-investments—because we can see an opportunity that fits our profile and the risk reward profile we’re trying to develop for individual portfolios.

Franco: Let’s turn again to the global perspective; in particular, the emerging economies and the growth markets around the world where we’ve seen volatility. How do you assess that? Do you see through it?

Gardella: There’s been a flight of capital from many emerging economies. We have a very large presence in China and in Asia, in general. We see the long-term opportunities set in their long-term growth is inherent in our portfolio; we see it in the top line and the bottom line and that keeps us committed to those regions. It does give you pause that when capital comes out, it creates uncertainty and instability within the foundation of that community’s private equity GPs and firms and LPs. When you do your diligence on the next commitment or investment, you have to be mindful of that instability. But from a macro, top-down standpoint, this may be one of the better times to allocate capital to those segments, if you can find the right GP to work with. Latin America is a great example for Adveq, in particular, because we’ve been researching it, we’ve been paying very close attention to it and we’ve made a very modest allocation historically, because from a top-down standpoint, we thought the activity over the last few years was very pro-cyclical.

Franco: What about the frontier economies—how do you assess those?

Gardella: We look at those also very carefully. We’re probably more conservative than others. One we are always sensitive to is the stability of the organizations we back, the governance that they follow with not just their own firm, but within their portfolios and the institutional make-up of the markets coming in and getting out of not just capital flows, but also taxation and things of that order.

In general, we have felt that, tactically, we might make individual decisions here or there, but not make a huge wholesale decision to allocate heavily to the frontier markets, because we believe they are a derivative of some bigger cousin nearby and that the risk reward is not fully your benefit in the frontier marketplace. For example, we are more inclined to be heavily exposed to China versus one of the frontier markets that borders China.

If China gets a cold, they get pneumonia. Obviously, with China—as we’ve proven with our 12 years of investing there—we think our ability to profit, contribute capital to the marketplace and get it back out profitably, gives us fuller confidence to go forward. We haven’t seen as much of that in the frontier markets. It doesn’t mean it’s not going to happen, but when the markets are getting a lot of attention, we’re not sure it’s the right time to enter those markets and take that risk.

Franco: No matter where you are in the world, performance has to be the foundation for an investment decision. Responsible investing, though, has become very topical and seems to be growing, particularly in Europe. How is that influencing the way capital is deployed?

Gardella: It influences Adveq. ESG (Environment and Social Governance) topics are very important to us as a firm as part of our investment process. It is part of our due-diligence process. We have declined investments on this topic alone. Governance, as well, on the environmental side. We have profited by following these standards and principles. Whether or not it becomes an institutional concept as we’re seeing in Europe, or if it’s just good business principle behavior, it’s important to us. We know it’s important to our clients and it is an area you could still maintain the profit principle in your behavior and maybe enhance the profit concept as well.

Franco: Have you seen the GP community take on ESG in a serious way?

Gardella: Sporadically. We actually talk to each of our GPs about the topics of ESG, whether they are legacy or brand-new. Some meet the conversation without even understanding what ESG stands for. Others who do understand ESG are not sure if it’s worth their benefit. Then, there’s another side that wholeheartedly welcomes working with us on the topic because they see the benefits and also, it fits their principles as a firm.

It’s not going to happen overnight, but we believe it’s worth the effort and the push on our part to make it part of not just our business, but also the industry’s business.

Franco: I’m going to ask you to look forward. What two or three trends do you think are going to be most impactful on the private equity investing going forward?

Gardella: There are actually several of them. One: I think co-investments will be a major impact in this business going forward.

Two: as we spoke about earlier, this intermediation and the efficiency of our business is increasing. That usually translates into lower returns over time. It doesn’t happen immediately, but you could look at the private real estate marketplace as a benchmark to that topic. Twenty-five years ago, information flow on real estate was sparse. Private equity is still sparse in its information flow. Information flow is increasing in its detail and its uniformity in our business, which translates into a far more efficient business, which translates into lower returns.

Franco: So, to be successful in your business going forward, what’s going to be required?

Gardella: From our standpoint, specifically, it’s embracing these trends but never losing sight that we’re here to earn a profit for our client. Secondly, recognizing that customization is a big deal for our clients. And there’s no one-stop solution anymore for anybody in our business, whether it be Adveq or anyone else trying to service institutional investors. Historically, private equity has turned a deaf ear to the institutional investor. This change here, recently, is going to become far more LP-centric in the years to come.

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