The Swiss Twist on Private Equity Investing –

Urs Wietlisbach represents a new generation of Swiss. A product of the Information Age, he is part entrepreneur and part banker. In 1996, after spending a decade at Credit Suisse and Goldman Sachs, Wietlisbach and two colleagues founded Partners Group in Zug, Switzerland. Their inspiration? The realization that banking and investing were changing throughout the world. Their goal? Nothing less than an information technology-based revolution of the staid world of private equity asset management, in the most historically conservative banking environment in the world.

That lofty a desire probably wasn’t in the founders’ minds at the onset. Wietlisbach is himself the first to remember that such a claim overlooks how the three founders started in a 10-by-10 room in a Zug office complex where Alfred Gantner and Marcel Erni, the other co-founders of the firm, had their two computers, while Wietlisbach kept his day job at Goldman to support their efforts. Not exactly a garage startup, but pretty close.

Today Partners is a $7 billion alternative asset manager, with 11 different funds invested in Europe (50%), the United States (45%) and the rest of the world (5%). It targets three markets: buyouts (65%), venture capital (20%) and special situations (15%). About $6 billion of its assets are invested in private equity programs and another one billion is invested in hedge funds. Of its current assets the firm currently has $1 billion invested in U.S. private equity managers, including Battery Ventures, Draper Fisher Jurvetson, Menlo Ventures, Morgenthaler, New Enterprise Associates, Sierra Ventures, Summit Partners and TA Associates.

That deceptively simple description ends most discussions about Partners, but like Wietlisbach, Partners is as deceptively deep and complex as an Alpine lake. Wietlisbach says that the firm started with the intent to become one of the first of a new generation of “fully transparent” private wealth asset managers that would disclose to its clients all of the fees that it paid or was itself paid. It was a startling idea in a nation whose most famous ancient maxim is, “Speech is silver, Silence is golden,” and a revelation in the financial world where undisclosed payments are discretely made between the professionals who manage money for the world’s wealthiest people. But it allowed the group to form a $350 million private wealth asset management business.

The fledgling firm had found a niche in private equity investing in Europe, in the mid-1990’s relatively recently but at a time when Europe was still overcoming generations old barriers of fiscal conservatism. Different countries in Europe had (some will say still have) banking regimes that hark back to medieval times; tiered systems of banks that relate to different levels of governmental authority or geographies, with differing sets of regulations and regulators. This at a time when the European Monetary Authority was still struggling to insure the success of the Central European Bank and a single unified currency for the European Community.

The Old Days

At first Partners was a traditional firm. “We did investing, mergers and acquisitions, bought and sold assets and managed our clients funds, but there were lots of people that we were meeting who could not invest their money [in private equity] because of regulations in Europe,” Wietlisbach says. In the mid-1990s few pension funds and insurance companies in Europe had any stake in the private equity asset class. “Firms in the U.S. and the U.K. knew about private equity, but it was a different matter in continental Europe.”

After much thought the three partners decided to form a fund of funds and then list that partnership on a public stock exchange, so that investors across Europe would finally be able to take advantage of private equity investing. It was a groundbreaking idea, but, “We were just three guys without much of a track record,” Wietlisbach says. They knocked on doors across Europe and eventually met with the Liechtenstein Group (LGT), owned by the royal family of Liechtenstein, at that time one of Europe’s wealthiest and most closely held asset management companies.

LGT liked the idea, and in 1997 he formed a joint venture with Partners, called Castle Private Equity, which was established with $350 million of capital and listed on the Swiss Stock Exchange where it remains today. It was the first publicly listed fund of funds in continental Europe. Castle introduced another innovation: Because of its public listing, it was established as an evergreen fund rather than as a traditional PE fund limited to a fixed investment life. It is a characteristic shared by three other Partners funds since that time.

Blue Blood

However, shortly after Castle was founded, the royal family decided to sell its institutional asset management business to Invesco, so, says Wietlisbach, “Our relationship with LGT changed quickly, but the firm was also expanding. We were temporarily left on our own to manage Castle as our former colleagues at LGT left.” Partners had to hire additional senior managers. In that growth process, the partners met other investors in Germany who had seen the formation of Castle and who also wanted to invest in private equity but whose hands were tied by regulators.

So, in 1999, Partners created the Princess Fund, another innovation in asset management funds and the world’s first “principal-protected” PE fund. It was set up as a AAA bond and insured by Swiss Re as a fund of funds, but with its principal protected, so that pensions or other financial investors limited to no-risk investments could participate. If the fund loses money the LPs have no risk to their principal, which Swiss Re would repay. At the same time investors can participate in any upside earnings the funds generate.

With the $700 million Princess Fund Partners achieved recognition for what has become one of its hallmarks: the development and implementation of innovative financial, tax and administrative structures for its funds. Princess’s guarantee of a 100% return of investors’ money, its listing on the Frankfurt Stock Exchange and promotion and sale by ABM AMRO and Deutsche Bank, were first of their kind and provided the entree for the Group’s next innovation, funds with a Coupon Bond incentive.

In 2000, Partners brought out Pearl, a EURO660 million (euro) fund of funds, also with principal protection. And like many bonds it provided a 2% coupon, or interest on principal invested, per year, for the 10-year life of the fund. And, in the same year, another fund, P3, with EURO340 million designed for private clients of Germany’s Dresdner bank, which is also listed on the Frankfurt Exchange. It is a tax efficient evergreen fund that provides investors with tax free gains on their investments in the fund.

That same year, the Partners created yet another PE fund of funds (CSA PE), a $200 million fund that has quarterly liquidity. It was yet another technically complex financial structure that brought about an important change within Partners’ organization. “The need to know what was happening with cash flows on a regular and short-term basis caused us to develop a deep expertise in the flow of private equity throughout the cycle of investment, distributions and re-investment and that separates us from our competitors, like HarbourVest, Pantheon and Adams Street,” Wietlisbach says.

The year 2000 was a crucial time at the firm. In one year staffing increased two-fold, the techniques in mathematical modeling of PE were developed and the firm put its methodology for due diligence in place. “At that time, we developed our so-called Relative Value’ approach, which clearly differentiates us from other players in the industry. This approach which leads to an integrated asset management is crucial to our success as it generates more added value and goes beyond simple data mining and the homework done by the fund of fund industry.”

Wietlisbach says that the Relative Value approach is unique because it generates additional returns through an optimal mix and timing in the use of primaries, manager or financial secondaries, listed private equity and co-investments. The Relative Value investment strategy is supplemented by top down modeling Partners does, running models on the data from the 150 partnerships in which it participates and from the 3,000 portfolio firms in which those partnerships participate in order to achieve and maintain a target investment amount.

Wietlisbach says all of this extra work is necessary because of the evergreen and public nature of four of its 11 funds and because, “We run those funds with an over-commitment strategy.” For example, Princess raised $700 million all paid in by investors at the onset of the fund. But Partners commits more than the principal LP’s put up, leveraging the principal based on its knowledge of capital flows to obtain the optimal investment level.

Wietlisbach explains that Princess Management & Insurance Ltd. uses a proprietary over-commitment strategy to generate higher returns over the long term. This strategy aims to shorten the period during which the liquid funds are invested in the partnerships and to ensure that the targeted full investment level is maintained. Partners’ approach is based on statistical analyses that show that the draw down of investors’ commitments generally stretches over three to five years. Distributions can, under certain circumstances, begin to take place relatively rapidly, thus creating a contrary cash flow that generally prevents more than 65% of the committed capital from being actually invested at any one time, according to Partners. The resulting relatively low investment level limits the performance potential and the investor’s yield expectations.

Partners and Swiss Re developed an over-commitment strategy for Princess that controls the amount and timing of the commitments on the basis of data provided by two integrated models: the Cash Flow Forecast Model and the Cash Flow Monitoring Model. The Cash Flow Forecast Model uses historical data to predict cash flows and thus allows total commitments to exceed actual available capital. As a result of the over-commitment, and after the necessary development phase, an investment level of almost 100% can be achieved. The Cash Flow Monitoring Model monitors actual cash flows as they occur and enables a dynamic adjustment of the over-commitment strategy. At the end of November 2004 Princess was running an over-commitment of 46.5 percent.

“It means we always have to be at the top of our game.” Partners succeeded at just that across the 2001-2003 time period, although Wietlisbach says that returns were just “OK” for the period.

On the other hand, the Group actually had returns and all $700 million of the principal of the evergreen funds is intact. In addition, over the last three years Partners was able to raise an additional $1 billion in separate accounts, i.e. substantial client investments which do not flow into a specific product but are managed separately.

That takes us up to 2002, when Partners announced its first European buyout fund of fund of EURO250 million, and 2003, when the firm announced its first secondary fund of EURO500 million. It is expected to announce this month (February) a new European buyout fund of fund that will push its assets beyond $7 billion.

Having watched the ballooning of buyout firms over a short span of years, one has to wonder if Partners is setting a similar example among funds of funds. Wietlisbach makes one distinction in talking about Partners: “We’re really an integrated private equity investment manager, not just a fund of funds manager.” A big part of that somewhat oblique distinction is the firm’s “Value Navigator” databases. “It’s what led us to our secondaries work, our knowledge of the companies in which our fund managers have invested.” And while Wietlisbach won’t say it, one can easily imagine the firm evolving in any of several directions: using its modeling experience to move into public equities trading, investing an ever-larger percentage of its funds in direct investments, or merely acquiring more assets to invest in the sectors in which the firm already participates.

With around $7 billion in assets and 70 investment professionals, Wietlisbach says that Partners is already similar to HarbourVest, with the exception that the latter firm manages $14 billion. Asked whether Partners is going to grow to rival HarbourVest, he demurs. “Like HarbourVest, we’re a discretionary manager not an advisory manager. The typical path of growth for the latter type of firms is to try to grow into discretionary work.”

There is another aspect of how Partners is different from funds of funds, in that Partners doesn’t raise funds every few years for the $2 billion of assets in its evergreen funds, so it doesn’t have quite the overhead of a fund of funds. Investors in those funds take their profits as dividends, coupon redemptions or even distributions, but the principal remains in the hands of Partners for investment.

“Sure, we want to grow, but we’re growing carefully as there is capacity constraint in several private equity segments. Due to our relative value private equity investment approach and the mentioned capacity constraints we are not looking for fast asset growth through low fees.” Partners is positioned in the higher fee segment, which it says is justified because the group actively invests. “And our clients expect us to outperform the market.” Partners probably won’t grow to be like Hamilton Lane at $36 billion of assets. Instead, it sees itself more in the model of Adams Street Partners, and growing to $10 billion in assets under management over the next five years.

The Road Ahead

Asking someone like Wietlisbach for predictions is like asking to see the family heirlooms. Still, he’s somewhat forthcoming. He predicts that buyouts funds will continue to grow relative to venture funds because, “The most a fund can put into the typical startup is from $10 million to $30 million, before they reach an IPO or an M&A event.” Whereas Partners sees buyout transactions as “the real thing” in which large companies are being bought and sold.

He is quite optimistic about U.S. venture capital, with one significant qualification: “The problem with the VC market in the U.S. is one of access. You have to have access to the top 30 VC firms. It’s a small group of the names like NEA, Sequoia, Sevin Rosen, Sierra Ventures, Menlo Ventures, Greylock, Battery Ventures, Kleiner Perkins and Draper, to mention a few. If you don’t have access to those names you don’t succeed in venture capital. Period. We’ve invested in some emerging venture firms, with extremely clever people, maybe as bright as the people at those firms I mentioned. They do the right due diligence on their investments. But they just lag behind the top firms.”

“If I were an entrepreneur I would look at VC in the same way. I’d go to the crowd on Sand Hill Road first and if I couldn’t get any of them, then I would go to the second tier firms. As for LPs, everyone knows those top [GP] names I mentioned; they’re always oversubscribed. They always outperform the industry in good years and bad. The rest of the VCs have to struggle to get their dollars.”

On the topic du jour, Wietlisbach allows that Partners was very cautious about Asia up to 2002. But since then the firm has increased its investments in the region. “Over the next five years we want have 10% of our assets in the region and have also launched our Asian Pacific fund of fund,” he says. He ticks off four reasons why Asia is important: GDP growth, stable currencies that if they leave their current pegs will only appreciate, a strong regional market set to grow over the next 10 years, and “unlike the U.S. and Europe where there is a capital overhang, in Asia there is capital underhang.”

Wietlisbach appeared in Singapore just last November to announce the opening of a regional office. But Partners is expanding into a world where there are few proven managers and financial markets lack the stability of the markets in which it has fared so well to date. It’s going to be interesting to see if its plans for Asia work like a, well, like a Swiss watch.

URS Wietlisbach

Co-Chairman

Partners Group

www.partnersgroup.net

Age: 43

Education: MBA (equivalent) in economics and marketing from St .Gallen University in Switzerland, 1987.

Work History: Account Manager, Credit Suisse, 1987-93; Executive Director, Goldman Sachs 1993-96; Co-Chairman/Co-Founder, Partners Group, 1996-present.

Favorite Book: Angela’s Ashes, Frank McCourt. “The book is about the economic situation in Europe between 1910 and 1940 and describes the poverty that reigned at that time, especially in Ireland. It is a great book, because it talks in images, you get the feeling that you’re in the middle of it.”

Favorite Film: The James Bond collection.

Hobbies: Golf, skiing, jogging, eating, drinking and talking.

Best Personal Investment: Credit Suisse stock when it was a fallen angel and Intel Stock “I bought it [at $6.50 a share] and never sold it.”

Worst Personal Investment: Search engine EuroSeek. “I lost all of my investment on that one.”

Family: Wife who works for Tiffany & Co. (“That saves me a bundle. She gets a discount.”)

Biggest Challenge for PE: “Finding the jewel opportunities.”

If I weren’t in PE I’d be: an elementary school teacher.

Advice to Emerging Managers: “Be straightforward.”

Email: jborrell1@yahoo.com