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Small Deals Are The Best In Any GP Portfolio

14 September, 2010

Auda International LP and its affiliates, an independent global alternative asset investment advisors managing over $4.5 billion in committed capital, was founded in 1989 to advise the Harald Quandt family (established industrial house in Germany) on its private equity, hedge funds and real estate investments in the United States. Over the years, the firm has diversified its investor base and is seeking to enhance exposure in India. Against the backdrop of a difficult fund-raising environment where a host of Indian funds are out on road chasing LPs (limited partners or investors into venture capital, private equity funds) for fund commitments, Auda is currently very active in India looking at investing in four to five funds in the next 18-24 months. The firm currently has an exposure of $80 million into India with investments in funds like IDFC PE & ChrysCapital. In an interview to VCCircle, Menka Sajnani, VP (incharge of India investments), Auda International, talks about their investment strategy and the rationale of picking small and independent funds. Excerpts:-

 

What is your current investment exposure in India?

We have deployed around $80 million in India till now. We have five relationships in India commencing 2007-08. We have two pan-Asia funds as well which are focused on India. We plan to invest in four to five new relationships in the next 18-24 months. We have backed well known brand names such as IDFC PE and ChrysCapital. We initially began by backing more established brand names and overtime have evolved into backing more independent local teams managing smaller pools of capital.

 

India is witnessing a surge of small and independent fund managers who are on the fund trail. Is there a problem of plenty?

That’s precisely what is attractive for us in India. I think that’s the market to look at because you have high levels of selectivity, and that’s what makes India interesting from a private equity stand point. You can evaluate more than 100 managers easily but finding the one to invest in becomes very challenging. It is very difficult to find very good quality fund managers because India is a very young market.

 

What are the kind of funds you would look at?

We do have a preference towards small, independent teams with their skin in the game. Post IDFC and ChrysCap, we have not invested in any captives or very large funds. We would still consider captive funds but the case has to be compelling. Generally, we have a bias towards independent teams. We tend to prefer managers raising less than $500 million, and we look at three key dimensions when evaluating a fund: the team, the strategy, and the track record. We have to analyse the inter-relations between these three in terms of consistency, sustainability and relevance. For instance, is the team’s background consistent with the strategy? Is their track record sustainable and relevant to the strategy they plan to execute?

 

Why are you focussed on small and independent funds?

Across Asia, fund sizes have been expanding two to three times in 2-3 years whereas the PE ecosystem has not evolved that much. Raising a fund size from $500 million to $1 billion in two and half years doesn’t justify the PE landscape. We have started questioning the fund expansion strategy in a very short period of time and whether managers can really execute large deals especially when a lot of opportunities lie in small, mid-cap companies, requiring small pools of capital.

If you look at the track record of brand names–you can’t discount them entirely–their best deals are the smaller deals. The track record is actually based on the deals that are smaller. Is that sustainable when you start raising really large sums of money?

One of the other reasons why we choose to partner with small funds is that they are more hungry. They are more driven by carry (private equity manager’s share of the profits made on investments) than management fee (annual payment made by the LPs to a PE fund manager). For a lot of teams, which have spun out, it is the prime time of their career, and, for them, it’s really about proving their ability to raise money and execute. 

 

Why do you prefer backing independent teams?

That is something we made a conscious effort not to invest in captives. We may not discount them entirely but it really has to be a very strong case of leveraging the platform of the sponsors in such a way as to make a tangible impact to the portfolio.  

 

How do you see the trend of personality-led PE funds in India panning out?

I think you have to look at the team as a whole.  If Personality A is setting up a fund, it depends upon the kind of people they are working with. Are they working with people they have worked with before? Funds with two strong personalities could be potentially dangerous also. One main man running the show (connecting with LPs) and a second in command (responsible for execution), we like that. There’s a Chinese saying, ‘There can’t be two tigers on one mountain’.

Also, India is a market where not a lot of fund managers have much skin in the game. It makes the fund very interesting when there is a significant commitment from GPs.  I wish that could go up but we have also come across fund managers whose personal commitment to the fund is significant and we love that. These guys are investepreneurs and they love what they do. They are very few to come by, you can only see one in 200 and they are very compelling. 

 

Do we see the next bull run for PE now?

I see both. You see contraction and growth at the same time and it really boils down if they are able to raise their second fund. There are funds which invested at very high and peak valuations and will they be able to generate returns is a question, and their ability to raise funds will be seriously impacted by their Fund I & Fund II performance, which is where I see contraction. Where I see growth are the funds where industry veterans teaming up to go independent. In 2010, I am meeting lot of people who are exploring the opportunity of leaving their own funds and setting their independent funds. I am also meeting a lot of corporate groups exploring PE options.

 

How has India performed from a return perspective?

The market is very young. We are getting to see some exit from 05, 06, 07 vintages  but it’s very difficult to tell how India has fared on a global basis from a return perspective. You need to give it a couple of more years to arrive at a more informed conclusion. 

 

A lot of Asia focused fund of funds have raised money. Has the fund raising environment improved for Indian funds?

The fund raising environment is more difficult compared to what it was in 2007. It’s very difficult for a first time fund manager to raise money in this environment. In 2007, somehow it happened. A group of investment bankers or industry experts coming together and raising a fund, maybe it was doable in 2007, but it is not today.  Suddenly, this whole idea of having a cycle experience or having an experience of the downturn has become more important. The exit track record has become very important. It’s not just whether you can invest capital but whether you can generate liquidity for your LPs in the portfolio. Have you actually made exits in the career? Also, team stability is a key issue because there is so much of shortage of talent in PE. All these issues were also important in the past have come into the lime light today. I think the biggest issue of all is really your track record and exit strategy. 

 

How important do you think is an operating partner to a team?

The role of an operating partner is more pronounced in funds which have an activist style of investing. The incentivization has to be planned here. If all the incentivization is going to the investment team and very little going to the operating partner, then that’s a concern. 

 

What are a few things which you would not like to hear in a GP pitch?

The strategy which everyone conveys is we invest in small mid-cap companies, high growth, underserved sectors. It’s very difficult to understand how they are executing that strategy.  The whole “value add” bit is also a very loosely used term. Sometimes, I think, we may not need to have do value add, it’s really a perceived value add. It’s more about your relationship ultimately with the company .They don’t have to sit down and do all the fancy stuff. I am not against passive investors who do very little with their portfolio, and how they manage relationships with the promoters. On the other hand, I also like the active style of investing when it is clear the kind of tangible benefits they are bringing to the table.  I would like to know how they are aligning their interest with the promoters, structuring the deals and sharing the upside. 

 


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1 Comment
Anil Kamath . 6 years ago

PE investment class is supposed to be informationally inefficient market and hence the expectation of providing a higher risk adjusted returns compared to public markets. However, with time this inefficiency degree reduces as more market participants enter and then the ability by the GP team to provide a higher risk adjusted return than the public markets is a function of its ability to do the “value-add”. As Menka has mentioned most GP’s in India use this word very loosely and very few in reality actually add value to the business even where required. While 10 years back the informational inefficiency was high, it is no longer the case. The “value-add” factor would become a strong differentiator going forward while seeking committments from limited partners / investors. While I agree with Menka about seeking individual teams who has skin in the game, it is also important to balance this from the risk of something adverse happening to a key member or members of the team as ensuring continuity is critical since the investors have not choice of an exit like in a public market. This degree of this downside is far lower when its a institutional sponsored fund. Bottomline, in the evaluation this downside needs to be adequately addressed.

Small Deals Are The Best In Any GP Portfolio

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