Q&A: HQ Capital's Georg Wunderlin & David Pierce

Q: Are you concerned about the amount of capital entering the asset class?

WUNDERLIN: It’s not so much the dry powder per se that worries me; it’s the availability of deals. Some funds are getting bigger and sourcing attractive transactions seems to be difficult. This is what worries me most, and the pricing environment because of that. It’s more of a problem at the top end of the market. We still see attractive opportunities at the small and mid-end – although we do see some of the larger players scaling down and reaching out to targets they have historically found too small.

Q: How is this impacting client demand?

PIERCE: It depends on the client. Some clients are new to the asset class and they are looking for the broadest possible exposure to get returns that are commensurate with the perception of the risk they are taking. We find that particularly among Japanese investors, but even in Germany there are investors who are new to the asset class. We also have sophisticated clients who are very clear about what they want. Some of them want to do the large funds themselves and they need our help to understand the middle and smaller markets. What’s in vogue is private equity. There is a lot of money coming into the industry. It’s been a low-interest rate environment for a long period of time and people are looking for ways to get a better deal.

Q: How do you approach portfolio construction in this environment?

WUNDERLIN: Portfolio construction is the magic triangle of capital deployment, optimizing the liquidity profile, and optimizing the risk-return dimension of the portfolio. To build an optimal portfolio you use all three strategies: primary, secondary and co-investment. With SMAs [separately managed accounts], it is about custom-building portfolios based on the needs of specific clients. They might have a legacy portfolio with certain characteristics – perhaps it has dropped too deep so the NAV needs to be rebuilt or it’s generating a lot of distributions and these need to be put back to work but only to a certain extent.

Q: How much of a concern are rising prices in the secondary market?

WUNDERLIN: The secondary market is a mature market with subsegments: we speak about the traditional secondary market – the acquisition of LP interests – by transaction size and type, and then we differentiate between traditional secondaries and alpha transactions. These are more complex transactions that require some sort or input or active element on our side, for example restructuring a GP of a fund, buying out parts of the portfolio, or stapled transactions. Pricing is still very attractive for the smaller end of the market and those more complex deals.

Q: How significant are SMAs as part of your overall business?

WUNDERLIN: While one-third of our capital is SMAs and two-thirds is fund-of-funds, new capital coming in is about 50-50. I would expect the SMA share to continue to increase in size. SMAs are also often turning into evergreens. We are mandated to manage a portfolio according to a certain exposure level or liquidity profile. Once the portfolio has developed self-financing characteristics, it’s about continuing the deployment of capital and managing the portfolio to stay around these defined exposure levels. By nature, it’s a very sticky business, almost like an outsourcing solution for LPs. 

Q: What does that mean for your internal resources?

WUNDERLIN: It means using more of our portfolio managers’ time for direct client interaction, specifically senior portfolio managers. This requires support skills of a different kind to what you see in a typical fund-of-funds. You need more solutions capabilities: portfolio modelling, portfolio monitoring, risk management, structuring skills, implementation issues. It’s like a full-service solution rather than setting up one fund, raising the capital and setting the strategy in house with all the decision making in house. As an SMA provider, we wrap ourselves around the specific client situation depending on their resources, their skills, what they want to keep in house, what they want to procure from us.

PIERCE: It’s a much more dynamic relationship. It might equally have reporting specifications that are different from what you would see for a fund. You do require some customization and additional resources to do that, as well as explanation and interaction with senior professionals. And the relationship can adjust as the portfolio develops – the client might want to do more of this or less of that, be more involved or less involved.

Q: What is behind the recent consolidation in the fund-of-funds space ?

PIERCE: There are a lot of different factors. One is the regulatory environment became much more complicated a few years ago, meaning that if you were a smaller boutique operation a much larger percentage of your revenue went towards compliance and structuring. Also, LPs are trying to streamline their own relationships and make them more efficient, so you need more touchpoints with them to ensure you are in the mix. If you are a smaller manager the bandwidth you require to talk to LPs and find new ones is substantial and difficult to support. Fee pressure hasn’t been so much of an issue. Some of the consolidators, however, have been driven by a desire to get hold of sticky and stable fees from private equity.

WUNDERLIN: My expectation would be that the entire industry, not only the fund-of-funds space, will see consolidation pressure. Private equity is maturing and over the next decade we expect to see it converge with public asset management. There is an industrialization going on within our industry. It’s happening in a different way on the fund-of-funds and SMA side compared to the direct side, but you see it in the specialization of GPs – you are either completely specialized or you are global and have sector teams.

Q: How will the GP landscape change?

WUNDERLIN: We believe there will be multi-strategy alternative investment platforms and then niche specialists that cover certain sectors. Everything else is going to be difficult. Our industry is not only making deals in various ways, but we need to serve clients and think about our value proposition. It comes down to operations capabilities, structuring capabilities, advisory capabilities.

Q: How important is Asia to HQ’s overall business?

WUNDERLIN: Asia for us is relevant from an investment and a fundraising point of view. It’s an increasingly substantial private equity market and our investor base – being mostly continental European, Scandinavian and Middle Eastern investors – wants exposure to Asia. If Asia is around 28% of global private equity, for a sophisticated investor that wants to invest in globally, an allocation to Asia of at least 15% makes sense. We see that demand in our LP base. Asia is also attractive because it isn’t completely in sync with Europe or the US. From a fundraising perspective, quite a small share of our AUM is from Asia-based investors, but it’s growing. We see opportunities in Japan and China particularly.

PIERCE: The clients in Japan are mostly pension funds that have no experience of the asset class, so we have something to offer them. China is a much more heterogonous market with lots of private money as well as institutional capital. Our third market would be Korea. Each one has characteristics that are interesting. For Korea, we are looking more at SMAs; in Japan, it’s more traditional funds; and then China has everything, there are all kinds of things happening.

Q: How do you access high net worth private money in China?

PIERCE: A lot of liquidity has built up in China and the investment universe is limited. There is a lot of interest in deploying money more efficiently around the world, and one of those areas is private equity. The challenges are getting money out of the country and then managing it. There are very specific requirements – you need to have language skills, you need to be on the ground, you need to comply with local regulations, you need to comply with local expectations and manage those expectations. The clients are first-generation entrepreneurs, so they have very high return expectations. One of the difficulties for wealth management companies is getting clients to accept that it makes sense to deploy across asset classes, to have lower rates of return in certain asset classes, and to have a more balanced and durable portfolio with more steady performance. 

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• Topics
• LPs
• Fund-of-funds
• Secondaries
• Fundraising
• HQ Capital
• Asia