Scrumming for Funds –

Chris Meads looks like a rugby player. A native New Zealander, he stands 6-feet-4-inches tall and is built like a, well, like a rugby player. He plays rugby for fun, coming from one of New Zealand’s well-known rugby families. This fifth generation Kiwi now lives in Hong Kong, where-as a partner for the fund-of-funds investor Pantheon-he tries to out-muscle competitors in the giant scrum known as Asian private equity.

Meads’ experiences of battling in a real scrum have served him well. As a global fund-of-funds LP, he must compete against several large investors that are all vying for the same funds that he is to participate in. Pantheon competes against such LPs as HarbourVest Partners, Adams Street, GIC Special Investments and Alpinvest Partners, as well as some U.S.-based firms that are investing directly in Asia, such as the Common Fund and the University of Chicago.

Rhoddy Swire founded Pantheon in 1982, as part of a management buyout of an English private equity firm, GT United Kingdom. Swire continues as one of the three managing partners of Pantheon today. The firm makes fund-of-funds investments, performs research on asset allocation and performance, and participates in 500 private equity partnerships in 30 countries.

Meads, who has worked at Pantheon since 2001, runs the Hong Kong office of Pantheon. He’s in charge of managing investments in Asia, which total around $450 million spread across three funds – a 1994 fund-of-funds of $69 million, a 1997 fund-of-funds of $169 million, and a third fund raised in 2000 of about $160 million. Meads oversees his firm’s investments strategy, investment selection and client reporting.

The first fund-of-funds focused on VC funds and expansion capital, and secondaries (the purchase of portfolio assets from other LPs). In the second fund, Pantheon increased its commitments to buyout firms, while the amount of investments in VC remained about the same, and expansion capital shrank. The third fund, which is currently being invested, follows the trend of increasing the number of commitments to buyouts funds, while venture remains steady and expansion capital continues to decline.

Prior to 1997 and the Asian financial crisis, China, Southeast Asia and India were geographies that Pantheon invested in. Since then, Northern Asia, particularly Japan and Korea, have increasingly become important areas for the firm. Meads says that the biggest distinguishing factor for him is the location of the VC firm he is investing with. In the past, he says, his firm invested in Taiwanese managers who in turn provided exposure for Pantheon in China. Now, Pantheon is considering whether to place funds with firms already on the ground in China.

Reality Check

Most LPs probably spend much of their day reviewing reports, analyzing firms, dealing with their managers or negotiating terms with their venture partners. Meads, however, spends much of his time with his fund managers across Asia who are raising new funds. He tries to be proactive, choosing to visit managers in which he invests or to meet with firms with whom he may invest in the future. Meads says that he likes to review his managers and their investments, and meet with the investment teams at VC firms to better understand the markets that they are involved in.

Meads also goes one step further and meets with the most significant portfolio companies that his fund managers invest in. He says that he likes to ask them about how and whether his managers are effective VCs. Part of the reason for this is the need to understand which funds are really good VCs.

“When a deal is good, many managers like to claim a role in a portfolio company’s success,” he says. “We’re interested in knowing who was the most influential and what they actually did before we invest in a fund.” This is especially important in Asia, where Meads says that investor protections and corporate governance is less developed. “We rely upon our fund managers to protect our investments,” he says. “And the key to that is whether they are truly active” participants in their portfolio companies.

At present, Meads focuses on the most experienced regional funds-funds that he says combine a knowledge of local markets with a Western venture operating model. “We tend to favor funds like Walden International’s regional funds,” he says. And in some cases, Pantheon invests in managers of country-specific funds, such as in Australia, Japan and a growing number now in China.”Japan has such a strong affinity between local businesses and local fund managers that they have a stronger deal flow than regional funds.”

Track Record

Meads, however, notes that the most important factors to determine where Pantheon will invest depends on the experience of the teams and where their firms have decided to invest. In the end, that comes down to a frequently repeated mantra: “Manager selection is everything.”

Meads, however, sees some themes developing in Asia. One of them is a positive change. He sees genuine, significant and promising returns from Asian private equity funds for the first time since 1997 with “the activity in buyouts especially cranking up.”

The negative side to all of the Asian investing going on is that there is a relatively small group of experienced managers there and that “access to such fund managers” is becoming a key issue. And as interest in investments in Asia has increased, me-too investing has begun in the region, Meads says, with semiconductor foundries being the latest sector of interest at the moment. “Eighteen to 24 months ago it was BPO [business process outsourcing] Call Centers. There were funds raised just to invest in BPO companies,” Meads says. “I couldn’t imagine that having happened. It was hard enough justifying a single investment by a fund into a BPO.”

To Tell the Truth

Talking at a recent conference panel, Meads advised the VCs in attendance that they could probably “skip the chart on macro growth in China’s economy. You can safely assume that I’ve seen that one already.” Meads recalled that comment and laughed. “Yes, well, I’d modify that somewhat,” he says. “You can say that VCs can skip the chart showing 1.3 billion Chinese consumers buying a fill-in-the-blank chart. I know that one already, too.”

It’s indicative of a lack of experience, Meads says, when he hears a fund manager say “they believe in market timing,” or “they can predict the stock market in Asia,” when it is well known that markets are unpredictable.

“The best thing that a fund-raiser can do,” says Meads, who always likes to stress the positive, “is tell us what they’ve done wrong in the past that didn’t work and why. Tell us what they learned from a failed experience and how they have refined their thinking based on that.”

Meads’ Report Card

We asked Meads to weigh in on the key questions that we ask in our annual survey of limited partners. (See last month’s issue.) Meads agreed, but cautioned that he speaks from the context of an LP investing exclusively in Asian venture and buyout funds.

Succession. Few firms in Asia have had to deal with this, although when they do, it’s going to be a big issue, because PE funds in the region are dominated by a couple of individuals, he says. “Over time they’re going to have to share economics with the juniors [in their firms], and I just wonder if that is going to be a smooth process.”

Carry Fees. “In Asia it’s been an interesting, academic issue. Not a lot of fees have been paid,” Meads says, referring to the lack of success and profit in private equity until recently. Going forward, however, it’s going to be a concern, especially among buyout funds, Meads notes, because of the deal-by-deal fee payment that some firms use and that others are introducing. “Pantheon is not interested in supporting that model of fee payment,” he says. The problem, he says, is that the structure causes the negotiations over a clawback mechanism to be complex and complicated, especially in Asia where tax structure issues of deals are already complex.

Management Fees. In Asia, management fees are sensible, which reduces the incentive for PE firms to raise incredibly large funds. In Asia, a manager may raise a $700 million fund, but will charge fees on a $500 million fund, “which removes the moral hazard of raising too large a fund.” Because “if you wanted to look at large funds cynically, you might say that a manager could raise a fund and just live off the fees and not care about the rate of return to LPs or the carry.”

Communications. “GPs are improving,” says Meads, though there are still a few managers who think that reports to LPs should be every six months, but most are moving to quarterly reports. Meads says that GPs in Asia are making more use of advisory boards for the first time, and that they recognize the need to keep LPs apprised of staff changes. “LPs don’t like surprises, especially in Asia.”

Writedowns. Meads is not concerned about this issue as it relates to fund managers in Asia.

Terms and Conditions. The fine print of governing agreements is giving many LPs fits. Meads says he carefully looks at the key-man clause, since so many teams are dominated by one or two individuals. “Having one or two people driving a firm is fine, but we have to be covered if someone leaves. And that is taking time to negotiate.” The other issue on which he spends time is that of no-fault divorce. “We’re encouraged that this is becoming more common in Asia. We prefer to see it in the agreements, and GPs are beginning to understand that LPs won’t trigger such clauses without serious reason.”