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Embracing the Idiosyncratic

Constructing private equity portfolios is equal parts art and science.


s if there wasnt enough burn tactics are gone. Rather, winning to discuss, the role of private-equity strategies differentiate private equity in our themselves these days by fundameneconomy jumped on- tally transforming businesses. Better stage during the Repub- alignment between owners and manlican presidential primaries in January agers through shared equity interest is and February. Opposing candidates a motivator, but it really boils down to questioned whether Bain Capital, Mitt the imperative of achieving enhanced Romneys former private-equity firm, performance for the survival of manBY GEOFF CAREY, CFA has been a net benefit to the U.S. For- agement and private-equity investors. Portfolio Manager gotten in the rough and tumble argu- In the short term, restructurings can ment, among other things, is the fact suppress employment, but ultimately that teachers, firemen, policemen and success is determined by growing rev- sufficient to cover capital calls during other state employees are the primary enues through more effective business periods of depressed public markets. beneficiaries of private equity, through strategies. For many companies backed Further, having adequate liquidity also their public pension funds. Universi- by private-equity capital, competitive- provides flexibility to engage in tactical ties, foundations and corporate pen- ness is returned through introducing opportunistic investing that may also sion funds round out the majority new products, improving operations, involve private equity funds. Because of private-equity investors. From an entering new markets and making se- capital is typically drawn down over overall employment standpoint, some lective acquisitions. These proven pri- three- to five-year investment periods, 20 million U.S. workers hold jobs in vate-equity management techniques it is not necessary to retain the full companies backed by private equity or have been adopted by leaders of public private-equity commitment in conseroriginally funded by venture capital, competitors, with favorable implica- vatively invested reserves, but it is genrepresenting 18% of total U.S. em- tions for overall U.S. competitiveness. erally advisable to keep a third or so of ployment, according to the Private Eqoverall commitments in more liquid, uity Council/National Venture Capital ALLOCATING THE UNUSUAL shorter-duration fixed income. Association. Now in the crosshairs of At Brown Advisory, all asset-allocation Our job in building portfolios the electorate, Bain Capitals 138-com- discussions begin with our three buck- that include private-equity investpany portfolio presently employs one et approach, which includes an oper- ments is to make informed judgments million people and generates over ating account for cash and liquidity regarding tradeoffs of a clients over$160 billion in revenue. needs, a core portfolio for growth and all risk tolerance, liquidity requireOur intent here is not to jump income, and an opportunistic compo- ments and performance objectives. into the political fracas but rather to nent for tactical and higher-risk, often We rely on quantitative inputs but provide investors some perspective on illiquid investments. Within the core ultimately make decisions based on the role private equity plays in the na- bucket, private equity, venture capital qualitative assessments. tional economy as well as our invest- and real assets can play an important Thats partly because private equity ment portfolios. The fact is, contrary role in promoting long-term growth, is a thorny asset class from an allocato the rhetoric, the days when profits but this allocation should be made in tion point of view. First, private-equity could be driven primarily by slash-and- the context of an operating account returns are widely dispersed with no
6 THE ADVISORY MARCH 2012

BY MARK COLLINS

Director of Private Equity

investable index. The performance da- We will continue this practice going well as the fortitude to stay the course tabases that do exist to track private eq- forward, but in addition, we are devel- in the darkest days enhances the prosuity returns are rife with survivorship oping this year a vintage fund vehicle pects for long-term outperformance. bias, or the tendency of failing funds that will allow for client participation to suddenly drop out of databases, ar- across our offerings on essentially the GLIMPSING THE MEGATRENDS tificially inflating the average returns same economic basis as beforebut As stated, one invests in private equity of remaining funds. Together with with much more flexibility. Note that over a period of years, so instead of tryepisodic fund raising and variations in real estate as well as other income-pro- ing to pick a precise entry point based fund reporting and communications, ducing private-equity strategies will on the days macroeconomic winds, private equity is characterized by dis- fall outside this vintage-year vehicle. one should look instead to the longtinctive as well as quirky attributes. Within private equity, conven- term trends to invest alongside. As we Since part of the appeal of private tional wisdom encourages consistent look ahead, we find plenty of opporequity is the ability to tap into the participation over vintage years. In tunity in macro trends and company unique qualities of individual manag- contrast to the public markets, the risk formation. Within technology, mega ers and strategies, we are reluctant to of market timing plays out over much themes including social media, cloud overly diversify this asset class, which longer time frames. Were mindful of computing, big data storage and cyis charged with generating the highest the merits of consistent participation, bersecurity underpin explosive growth. returns. Depending on the prevail- but we also adjust commitment size In the health care sector, health care ing private-equity environment and based on our appraisal of the attrac- services and IT demands are spawnthe availability of managers in whom tiveness of the subsectors of private eq- ing promising electronic records and we have high conviction, we typically uity. Not surprisingly, some of the best payment companies. Within clean introduce our clients to only four to long-term returns are achieved during technology, the next generation of eight funds a year. periods when private equity is compar- energy efficiency, energy storage, polatively out of favor. For example, 2001 lution control, alternative energy and ACCESSING THE EXCLUSIVE was one of the best-performing vintage resource extraction companies are on In assessing funds as they come to mar- years in decades, with a median fund the march. And in private equity, a ket, we draw on industry relationships internal rate of return of 26.8%, ac- recession-prone global economy will and our Alex. Brown & Sons roots. cording to Preqin. In our view, a con- generate opportunities for skillful (Alex. Brown was, for many years, trarian mindset is advantageous both managers to restructure and transthe countrys leading underwriter of in terms of fund commitment as well form global companies. These and venture-backed IPOs.) We also draft as having an overall asset allocation other major long-term return drivers, behind the longstanding expertise of framework that can sustain a private- along with specialty strategies, will be certain partners and benefit from the equity program during public market expressed in our forthcoming privateinsight of clients and board members downturns. During these times, the equity fund opportunities. of our firm. Further, we are themati- pace of capital calls often increases as cally proactive as we ferret out strate- managers seek to invest in temporargies and funds with a discernible edge ily depressed or mispriced assets while whether in the form of regional or sec- distributions are few and far between. tor expertise. We have found that our most successOur approach over the years has ful funds are investing when others been to form feeder funds to enable cli- are on the sidelines. They also throttle ents to access individual funds at com- back when valuations are extended mitment levels below the $5 million and work most aggressively for distriminimum common in the industry. butions. Having liquidity available as
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