Invest it like Yale.
Secondary Private Equity. Many large investors are so successful because they hold a high quota of private equity in their portfolios over the long term. "Even for wealthy private investors and smaller family offices, however, this is not so easy to implement," explains Florian Dillinger, Matador Partners Group AG. "In order to create easy access to this asset class for them, we have founded Matador".
When David Swensen assumed responsibility for the Yale Foundation's investments in 1985, the elite university's fund was just one of many small institutional investors in the USA. Today - after 35 years of exceptional performance - the Yale Foundation is playing in the Champions League with around 30 billion US dollars in assets. And Swensen is considered the prototype of the successful long-term investor.
"Right at the beginning of my career I asked myself how he does that," says Florian Dillinger, Matador Partners Group, "and the answer was very simple: the key to success was that Yale always invested around one third of its assets in unlisted corporate investments - private equity, venture capital. After all, the stock market reflects only a very small part of the economy. The more exciting things are often found outside the capital market.
Florian Dillinger has been working in this field since his studies and in 1998 he even wrote his diploma thesis on it. And still can't get away from it today. "All my investigations have brought a very clear result. Private equity is the superior asset class, it brings the highest long-term return with comparatively low fluctuations.
"The figures provided by data provider Pevara support this," nods Detlef Mackewicz, a long-standing advisor to the Matador Group: "Since 1991, private equity funds in the USA and Europe have achieved an average performance of 10.5 percent per year. And the risk of making a loss over the seven to ten-year term has been extremely low. They are particularly fascinated by the fact that this way of investing money is also easy on the nerves. "Because of the independence from the capital market, investors don't feel the fluctuations so strongly, the whole psychology that is often so stressful on the stock market is out," explains Dillinger. "This is simply due to the different valuation methods," adds Mackewicz. "While market prices for shares and bonds are determined every second and therefore there is always massive over- and underpricing, the value of private equity investments is only determined on a quarterly basis and, moreover, is typically not communicated to investors until 45 days after the end of the quarter. That takes a lot of pressure off."
The conclusion is crystal clear: "Learning from the successful means adding 15 to 20 percent private equity to your portfolio," Dillinger points out.
That is the theory. But the difficulty lies in the practical implementation. "99 percent of investors do not have reasonable access to this asset class. After all, to be successful in this segment, they need a lot of capital and even more know-how," Dillinger makes clear.
Even the necessary financial resources are too high a hurdle for most. "As a rule, first-class funds require at least five million US dollars in capital commitments. If I want to invest in funds with different starting years and diversified across sectors - and that is an important prerequisite for long-term success - I have to subscribe to 20 to 25 funds over time. That means investing 40 to 50 million in private equity. If this part is then to make up 20 percent of the portfolio, it must already weigh a quarter of a billion," the professional calculates. He is not convinced by the cheaper variant of the funds of funds either. "The double cost structure then reduces the return far too much.
In addition to the necessary capital, the ability to select good funds is also an obstacle. "After all, the quality of the manager is a key variable. After all, private equity is not just about providing companies with capital. After the purchase, a positive development must be actively initiated - for example, by providing support for the expansion and development of the business model, expansion strategies, acquisitions or efficiency improvement measures. A great deal of entrepreneurial skill is required here," Dillinger makes clear.
Apparently not all private equity managers have that to the same extent. "In no other asset class are the differences between the best and the worst funds as great as in the private equity market," Detlef Mackewicz informs, adding: "The best 25 percent of all funds achieved an annual performance of 18.3 percent in the USA and 17.5 percent in Europe. The results of the top five percent are also remarkable with an annual performance of over 30 percent. In contrast, the worst five percent achieved a negative return".
According to the experts, investors could also learn from David Swensen's success in terms of selection. "He focuses on the funds with the best results in the past and does not experiment. Those who have been successful over a long period of time are obviously capable of something and thus offer the best conditions for delivering above-average results in the future as well".
However, such quantitative analyses are only the first step. It is also important to talk intensively with the management, calculate returns, question strategies and exchange ideas with other investors. "We want to know exactly whether and why investors were satisfied with the fund. That is a lot of work. But when we are in the same boat with a manager for ten years, we have to have thoroughly tested the manager beforehand," explains Mackewicz.
Because both challenges - minimum investment and selection ability - deter a great many private investors from investing in private equity, Florian Dillinger founded the Matador investment company in 2005. "I wanted to create a meaningful, listed vehicle that could be deposited in a securities account and through which every investor could add the desired private equity quota to his portfolio". In the meantime, it has grown into a private equity portfolio that is broadly diversified in terms of industries, regions and economic cycles. "And because I am convinced that things are still a bit better than with pure private equity investments, we have specialised in the area of secondary market funds. The secondary market - so-called secondary private equity - comprises the purchase and sale of shares in existing private equity funds. "From a risk/return perspective, this is by far the best strategy."
Two aspects are particularly important in the current uncertain economic and financial situation. "Via the secondary endowment policy market, we can now buy shares in first-class funds at high discounts compared to the presumed goodwill. The initiative usually comes from the seller, who wants to - or even has to - part with his shares", explains Dillinger, "this naturally increases the yield potential in the long term".
"But even more important today is that we know exactly what we are buying," adds Mackewicz. A private equity fund is always a kind of black box. Investors transfer capital and do not know where the fund manager will invest it. With secondary investments, the situation is completely different. "The assets are already included in the primary funds, the problem cases are as well known as the high flyers. The portfolio can now be valued very well".
Especially now, when the economy is struggling with the second wave of corona in the winter half of the year, Florian Dillinger therefore sees himself in an extremely good position. "The reports from the second and third quarters of 2020 are on the table. We know how the companies fared in the first wave. The discounts have levelled off at 20 to 30 percent, and we can now take our time to look for particularly attractive investment opportunities".
They have apparently already found a few. "We were able to increase two of the funds in which we had already invested at a discount of 30 percent because an investor had to part with his investment for liquidity reasons. In addition, we added a new fund to our portfolio at a 25 percent discount, which meets all our quality criteria. We expect both transactions to yield net returns of between 12 and 16 percent per annum," says Mackewicz.
And that, Dillinger hopes, is only the beginning. "The next twelve months will be extremely exciting for us. Crisis years like 2002, 2009 or even now have always been the most attractive investment years in the private equity sector. This applies even more to secondary investments, since we can buy there at interesting discounts. And because the economy will probably not recover as quickly as many had hoped, this ideal constellation will probably remain for some time to come. We will use it and want to be fully invested by the end of 2021.
And then? "Then we wait. Interest rates will probably remain very low for a very long time. That seems like doping for the private equity managers. It gives them the opportunity to restructure their companies at extremely favourable conditions or to advance their business. We want to profit from this," summarises Florian Dillinger and smiles: "I am curious to see how the comparison between us and the Yale Foundation will turn out in seven years' time. Because we buy at a discount, we should actually have made even more returns". ®
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Five jokers for secondaries.
For investors, investments in secondary private equity funds offer five interesting advantages over primary funds:
Firstly, secondary investments result in faster capital calls. This results in an accelerated build-up of assets. The J-curve effect common to primaries is thus weakened or completely avoided. Investors can thus not only expect earlier returns. They also have immediate access to a diversified portfolio of funds of different vintages, regions and styles.
Second, secondary fund managers do not buy a black box. The assets are already in the fund and can be well valued. This reduces the risks.
Third, the investor can add vintages of funds that are no longer available on the primary market.
Fourthly, costs are lower because the fund has a shorter maturity and the management fees for the first few years have already been paid by the original investor, who is now selling his shares.
And fifthly, the transaction often results in discounts to the presumed goodwill because a seller wants to sell his share and is therefore prepared to make concessions on the price.
For Florian Dillinger and Detlef Mackewicz, however, this type of investment involves a great deal of analysis. Firstly, they evaluate the respective target companies. Secondly, the managers of the private equity funds. And third, the secondary market funds themselves. "What is important is that in phases such as today, they have enough liquidity to be able to buy cheaply, and that they do not compromise on the quality of the companies and the purchase prices when selecting their investments," explains Florian Dillinger.
The listed investment company Matador currently has holdings in 17 private equity funds with a total of around 1400 companies and plans to expand its portfolio significantly in the coming months. The shares are traded on the Berne Stock Exchange and in Germany (ISIN: CH0042797206). Through this vehicle, a broadly diversified secondary private equity portfolio with no minimum investment restrictions is now available to all interested investors.
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Matador Partners Group AG
Grundacher 5, CH–6060 Sarnen
+41 41 662 10 62
Foto: Michael Doolittle/Alamy Stock Photo