September 21, 2015
Interviewed by: Tom Franco
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PE as the ‘Regenerative’ Asset Class

As the private equity industry has matured over the past 30 years, the number of fund managers has increased exponentially and the ways of doing business have changed. But the one constant has been the type of people who are successful as private capital investors, says Abbott Capital’s Jonathan Roth.

As the private equity industry has matured over the past 30 years, the number of fund managers has increased exponentially and the ways of doing business have changed. But the one constant has been the type of people who are successful as private capital investors, says Abbott Capital’s Jonathan Roth.

PE as the ‘Regenerative’ Asset Class
With Jonathan Roth of Abbott Capital Management

Dan Feder, Washington University Investment Management Co.: Hello, we’re here with Jonathan Roth of Abbott Capital Management. Welcome.

Jonathan Roth, Abbott Capital Management:
Thank you.

Feder: We’re here today to have a conversation about the work you and your colleagues do at Abbott. Could you provide us with a bit of background about what you’re doing at Abbott and the programs you manage?

Roth: I joined the firm in 1992 and it’s really been interesting to see how the firm has evolved as the marketplace has evolved.

When we began Abbott in 1986, we were one of a handful of players charged with the responsibility of building private equity portfolios for institutions. These institutions at the time were just beginning to get into private equity. Now, roll the tape 25 to nearly 30 years later, it’s a well-established asset class. The way people are initiating private equity portfolios and practicing the investment strategies has really evolved and, as a firm, we have had to evolve with those changes.

In addition to maintaining a presence of building core-diversified private equity portfolios, across all strategies—venture capital, growth equity, buyouts of all shapes and sizes around the world, particularly in the developed markets—there’s a growing need for specialized types of portfolios. Also, [there’s] a growing interest in shorter-duration strategies, because people are wanting to see more returns on a faster basis. The patience factor that we were always preaching back in the ‘80s and ‘90s doesn’t seem to resonate as well today. People want to see returns.

Tom Franco, Clayton, Dubilier & Rice: It’s an on-demand culture, Jonathan. You know it’s the Uber.

Roth: Yeah, exactly. We have an on-demand type of “I cannot wait 4 to 6 or 7 years to see how these investments are going to play out.” I can appreciate that, but having seen programs develop over 20 to 25 years, it’s really important to think of the long-term with these private equity strategies and not get so caught up with short-term market swings. That’s where I think some of the challenges lie for institutional investors.

Feder: It’s interesting because the power of compounding is just an awesome thing, right? And the downside of reinvestment risks is also a pretty formidable thing.

Roth: Right. Stan Pratt, one of our founders, had this expression, “Would you rather have a fund with an average duration of 6, 7 or 8 years and a 15% rate of return or would you rather invest with something over 3 years and get 25% and then have to put it back to work again and try to get that same 25%?” That’s where I think we see a lot of this push and pull in terms of duration versus IRR versus multiple.

Feder: In your work, do you try to educate the client in this or do you figure out a way to try to accommodate the instant-gratification gene? How do you go about working with clients?

Roth: It’s a combination of both education and accommodation. And accommodating some unique needs, while also making sure we can still build the foundation. We think, at the end of the day, a successful client of Abbott is someone who looks back over 20 or 25 years and we have these types of clients who have generated returns of 17 or 18% net over that long period of time. You can see the predictable nature of cash flows with those types of mature portfolios.

Franco: I’d like to go back to the 1980s. I bet you knew every PE manager in the U.S. To fast forward to today, how does that change the nature of your work, basically?

Roth: It’s a great question. With the maturation and the development of the private equity business, going from what we used to call “alternative investments” to LBOs to private equity, the proliferation of managers (not just in the U.S., but around the world) is an enormous challenge. Having said that, there’s also been an amazing development of information and data collection that was nonexistent in the 1980s and that is much more widely available today. Not all of that information is always accurate, but getting information about people, organizations and investment strategies is a lot easier today than it was in the 1980s, when there were a handful of firms you can quickly rattle off and feel you could cover the landscape of middlemarket buyouts or largecap buyouts.

It does create both a challenge and, I would say, an opportunity. The opportunity lies because, within the increased level of competition, there still remain crevices, edges and specialization opportunities. Developing markets will have developing managers that can eventually become the brandname firms that many people know today, but may not be around in 15 or 20 years. There are a lot of brandname firms—start with Forstmann Little. A lot of brandname firms have evolved and other firms have started and come into place.

Franco: So, it’s a pretty regenerative asset class?

Roth: I think it is an absolutely regenerative asset class and it’s because the people who have tended to be in the asset class are some of the smartest, most hardworking and intellectually stimulating, but they’re also attracted as rational economic human beings. It’s a very lucrative business to be in and the power of all those, collectively, really does attract people who can create an enormous amount of value from investors and themselves. That’s the way it should be.

Feder: There’s the size and the number of managers, but is there also something at play as maturation goes on or has taken place around the person or the background of the people that get into the business? In the early stages of the industry, if this is an industry, people who are going into private equity as fund managers, or venture capital as venture capitalists, would come from all sorts of places, all sorts of backgrounds, and were—

Franco: —Entrepreneurs.

Feder: —Discovering a way to invest and figuring it out. Now, we have businessschool courses and we have twoyear rotations and then twoyear rotations and then rotations within firms and so on and so forth. Where do the creative geniuses come from when you get this maturation?

Roth: They’re coming from a collection of different experiences. There’s certainly operational expertise that people are often bridging from running a business to owning a business to buying businesses. There are entrepreneurs—Andreessen Horowitz is a great example of fantastic entrepreneurs who’ve now established a premier venturecapital firm. It really varies, but I think because of the growth of the business and the industry, you now have tools being developed in universities that are also arming graduates with skillsets that are allowing them to get into the business in a more traditional way. I can’t tell you if there’s any one formula I’ve seen that’s more successful than the other, but I think it’s a combination of motivation and a keen interest in building businesses—because, at the end of the day, that’s what we think private equity is all about—and generating strong results and building enduring businesses that can become leaders in their industry.

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