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PE/VC Investing from the Perspective of Large Long-term Investors 从大型长期投资者的角度来看 私募股权与创业投资

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PE/VC Investing from the Perspective of Large Long-term Investors 从大型长期投资者的角度来看 私募股权与创业投资 - PowerPoint PPT Presentation


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PE/VC Investing from the Perspective of Large Long-term Investors 从大型长期投资者的角度来看 私募股权与创业投资. Second Annual China VC/PE CFO Conference 2 September 2011 SUNG Cheng Chih 宋诚之. Characteristics & Examples of Large Long-term Investors. Common Characteristics.

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pe vc investing from the perspective of large long term investors
PE/VC Investing from the Perspective of Large Long-term Investors从大型长期投资者的角度来看私募股权与创业投资

Second Annual China VC/PE CFO Conference

2 September 2011

SUNG Cheng Chih宋诚之

common characteristics
Common Characteristics
  • Captive relationship with legal asset owner
  • Large community of ultimate stakeholders with formal governance structure
  • Low cash outflows relative to fund size
  • Investment policy driven by explicit, actuarial or proxy liabilities
  • Generally with realrisk/return orientation
  • Diversified portfolio across multiple countries & asset classes, both public & private
  • Selective active engagement with investee companies
leading large long term investors
Leading Large Long-term Investors
  • Sovereign Funds:
  • ADIA, CIC, GIC, KIA, NBIM, Temasek
  • Central Banks:
  • DNB, HKMA, MAS, SAFE, SNB
  • Pension Funds:
  • APG, CPPIB, GM, NCSSF, OTTP, PGGM, QIC
  • Endowments:
  • Harvard, MIT, Stanford, Yale
  • Foundations:
  • Hewlett, WellcomeTrust
underlying investment beliefs
Underlying Investment Beliefs
  • Risk is a scarce resource that needs to be allocated efficiently
  • Asset allocation drives total investment risk
  • Long investment horizon confers advantages
  • Scale is a double-edged sword
  • Diversification across asset classes, geography, sectors, issuers & agents works
  • Alphas are for real, but hard to find or sustain
  • Willingness to forego liquidity is rewarded
  • Cost can be managed, less so for risk, and least for return
asset allocation practices of lt funds
Asset Allocation Practices of LT Funds
  • Portfolio construction of most institutional investors is centered on asset allocation which accounts for over 90% of total risk & return
  • Asset allocation seeks to harness risk premia embedded in & diversification across asset classes to meet return targets & risk constraints
  • Key constructs include asset class definitions, allocation targets, proxy & rebalancing rules
  • Model usually based on equilibrium assumption with many variants:liability-hedging, liquidity cycle, value-driven, multi-factor, risk-parity, tail risk-hedging & de-risking mechanism etc
role of pe vc funds in asset allocation
Role of PE/VC Funds in Asset Allocation
  • Case for PE & VC investments rests on equity risk premium, leverage & illiquidity premuim
  • Mixed evidence for value-creation through strategic guidance & management know-how
  • Some investors also see benefits from embedded leverage & smoothing effect on returns
  • Diversification argument has weakened due to introduction of fair value accounting
  • Most investors expect 3 to 5% return premium for PE & VC investments over public equities with commensurate increase in risk
search for common return drivers
Search for Common Return Drivers
  • Traditional allocation models make simplistic, static assumptions on volatility of PE and correlation with public markets
  • However observed volatility & correlation have risen & become more unstable in recent years
  • Investors are now keen to understand common risk/return drivers for both publicly & privately traded assets through quantitative models
  • Such models generally try to decompose return of private asset into systematic publicly traded component and specific private component
alternative private asset risk models
Alternative Private Asset Risk Models
  • Risk/return of private assets can be modeled by publicly traded assets in multiple ways:
  • a) equity of individual listed firms (proxies)
  • b) equity and bond indices
  • c) fundamental (e.g. Barra-type) factors
  • For example, under b), return Riof i-th private asset can be decomposed as
  • Ri - rf= ∑jβij(Mj- rf) + Ai
  • Ai= ∑kθikNk+ Si
  • where Mj = return of j-th equity or bond index, Nk= return of k-th non-public factor, Si = specific return of i-th asset & rf = risk-free rate
uses of private asset risk model
Uses of Private Asset Risk Model
  • Private asset risk models generally work better at aggregate level than for individual assets
  • Models shed light on both drivers for PE & VC investments and linkages with public markets
  • Integrated risk models give holistic view of total portfolio risk and allow risk budgeting & stress testing tools to cover private assets
  • Such models also provide fairer basis for evaluating value-added from manager skills
  • But gap between theoretical MTM-based risk models and observed PE/VC valuation remains hard to bridge
modeling commitments draw downs
Modeling Commitments & Draw-downs
  • Investors traditionally used rules-of-thumb to manage pace of commitment versus fixed allocation targets based on market value
  • Recent crisis highlighted multi-faceted liquidity risks such as inability to rebalance or to meet capital calls
  • Yale Model provides deterministic baseline forecasts of capital contributions, fund distributions &NAV based on historical data
  • More recent efforts employ stochastic models to estimate statistical dispersions of cash flows &NAV with emphasis on distress scenarios
key evaluation criteria
Key Evaluation Criteria
  • Track record
  • Portfolio composition
  • Succession plan, turnover and depth of team
  • Reference checks
  • Fund terms
  • LP list
  • Investment strategy and value-add
  • Risk/return profile
  • Disclosure and portfolio information
ilpa private equity principles
ILPA Private Equity Principles
  • ALIGNMENT OF INTEREST: carry/waterfall; fees & expenses; term of fund; GP fee income offset; GP commitment
  • GOVERNANCE: investment team; investment strategy; fiduciary duty; changes to fund; role of LPAC
  • TRANSPARENCY: management & other fees; capital calls & distribution notices; disclosure on GP; risk management; financial information; LP information
emerging trends implications for gp
Emerging Trends & Implications for GP
  • BAD NEWS: Among large long-term investors, there is a gradual but persistent shift away from fund & co-investments towards in-house direct investments
  • GOOD NEWS: Geographically, allocation to emerging markets is rising steadily for both public & private investments
  • RISING BAR: Investors are raising demands for portfolio look-through & greater disclosure
  • UNDECIDED: Meanwhile, debate lingers on the true value-add from PE & VC investments over (leveraged) public equities
long term differentiation strategy
Long-term Differentiation Strategy
  • For far-sighted GPs looking to build sustainable businesses, the fostering of open, trusting & mutually beneficial relationships with large long-term LP investors is key.
  • To this end, good understanding of evolving LP thinking on asset allocation, risk, liquidity & valuation issues can offer GPs a distinct edge
  • Furthermore, GPs who are pro-active in providing more data & valuation transparency and willing to help GPs solve their problems will stand out above the crowd in the new world of co-opetition
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