How to select your private equity fund manager

Rubi AryaMilestone Capital AdvisorsPrivate Equity is a boutique investment vehicle. Often misunderstood by many as equivalent to mutual funds, these vehicles invest large pools of individual or institutional money into companies as debt or equity participation. Returns from such investments are mapped to annual valuations and exit values rather than NAVs or indices. Being a very sophisticated vehicle, private equity needs managers of a much higher pedigree than regular market advisors. While choosing a theme to invest into, namely real estate or healthcare or education etc., one needs to understand that the value of one’s investment has no link to how the shares of that company moves in the market, but rather depends on how the investee company manages to achieve its goals using the funds. Careful study of the sectors or themes and a thorough understanding of the cash flow projections will make this investment experience not only worry free but profitable as well at the end. Now, let’s assume that an investor has an investible surplus of a few crores and is looking at a mid-to-long term options to park his money. Let’s also take a sector such as real estate, being one of the long shining sectors in the country. After having bought a house for ourselves we seldom assume that we know it all when it comes to this sector and the complexities involved therein. However, individual property transactions are just a small percentage of the overall complexity matrix that a fund manager has to handle while dealing in investments worth hundreds of crores. Usually, a fund manager will have a pipeline of deals in place, having done the due-diligence etc well in advance, prior to meeting a prospective investor. It is at this time when the investor should ideally probe into deal details such as tenure of investment, risks & mitigants, legal angles involved and also the qualification of the manager who will ultimately manage this investment. If the above leads to a positive scenario, the investor should go ahead and invest, or else call for more details. One should never go with personal assurances as this business is a mid-high risk one and only qualified fund managers should be given the chance to handle one’s monies.The experience of the fund manager comes in next….Wherein a seasoned manager having spent his years in similar transactions will give far higher confidence to the investor than a new outfit. Usually, top fund houses recruit extremely well qualified professionals from the same sector and pay top dollar to retain them as well. Also the leadership team must be viewed, as industry leaders and market influencers play an important role in establishing superior governance within the fund management setup. The next important check is the full cycle capability of the fund manager, wherein the manager’s experience in overseeing the earlier investments right from investing to exit, speaks volumes of his track record. Any fund manager who has only invested but hasn’t demonstrated any exits or strategies for the same should be avoided. The fund which has demonstrated an equilibrium between profitability and liquidity has performed most consistently and their managers should get priority. Funds that promise preservation of capital are low-mid risk funds with lower return projections. Depending on investor’s risk appetite he should be in a position to decide upfront on his investment outlook. The fund manager should be able to honestly describe the risk-return model to the investor in detail, prior to having him sign on the dotted line. In real estate, most funds are debt funds with low capital risk. After preservation of capital, investors need consistency in performance of the fund. Imagine a fund that might provide high returns when markets are good and also incur huge capital losses when the times are bad. This creates a negative perception of the company in the minds of the investors and any investor losing money once will never come back. The long term relationship with the investors is important and that can be maintained by providing consistent returns. There might be some ups and down in the market but overall consistency in fund performance is well accepted by investor’s community.Any investment is done with a core purpose of getting healthy & above-average returns. Returns are the deciding point weather an investor will come back to invest or not. The expenses that go into managing a fund could also determine ultimate returns. Fund houses with large teams etc tend to lead to erosion of returns due to higher operating expenses. Leaner the management team, lesser will be the expenses and will also indirectly result in higher returns.One should also consider understanding the profit sharing ratio which the fund presents to the investor. If the fund manager is aggressively marketing the fund, then he might settle for a lower ratio like 10:90 or similar. This ratio implies that the fund manager retains 10% of the profit earned by the fund, if the fund delivers more than the hurdle rate. Hurdle rate typically ranges between 11% and 12%. The investor gets remaining 90% of the profits. Lower profit share for the fund means higher management fees. Many fund houses globally are settling for very low management fees and have a larger share of profit. Management fee around 1.5% to 2% in India depending on the tenure of the fund. The investment decision can be made by the investor by looking at the history of the fund manager and his track record. A consistently performing manager will deliver returns even if moderate, so paying a higher management fee makes sense. Fund managers who have demonstrated extraordinary exit IRRs could be looked at with a higher profit share for the investor. Investment strategy pays a key role and its utmost important from the investors point of view .i.e. actively managed fund or passively. Actively managed fund managers generally perform well and out-perform the industry trends as compared to passively managed funds that depend on other fund managers which might not always perform as expected.Lastly investors should put their money on well proven themes. Micro markets in key metros in top cities will always give higher returns on investment than tier II or III cities. Industries like real estate, healthcare & education are forever green industries and will attract consumption in all economic scenarios, hence making good investment themes.