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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

Characteristics examples of large long term investors

Characteristics & Examples of InvestorsLarge Long-term Investors

Common characteristics
Common Characteristics Investors

  • 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 Investors

  • Sovereign Funds:

  • ADIA, CIC, GIC, KIA, NBIM, Temasek

  • Central Banks:


  • Pension Funds:


  • Endowments:

  • Harvard, MIT, Stanford, Yale

  • Foundations:

  • Hewlett, WellcomeTrust

Underlying investment beliefs
Underlying Investment Beliefs Investors

  • 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 process role of pe vc investments

Asset Allocation Process & InvestorsRole of PE & VC Investments

Asset allocation practices of lt funds
Asset Allocation Practices of LT Funds Investors

  • 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 Investors

  • 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 Investors

  • 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 Investors

  • 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 Investors

  • 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

  • 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

Selection of pe vc funds

Selection of PE & VC InvestorsFunds

Key evaluation criteria
Key Evaluation Criteria Investors

  • 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 Investors

  • 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 Investors

  • 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 Investors

  • 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

Pe vc investing from the perspective of large long term investors

Q & A Investors