LP interview: Hermes GPE

Hermes GPE is a keen advocate of co-investment. Following its formation in 2010 – a merger between Hermes Fund Managers, the principal asset manager of UK’s BT Pension scheme, and Gartmore Group’s private equity fund-of-funds businesses – the firm’s first initiative was a vehicle dedicated to club deals. 

The Hermes GPE PEC II Co-investment fund closed at $480 million in 2014. The bulk of it came from BT Pension, with State Teachers Retirement System of Ohio and the London Pension Fund Authority also making contributions. These co-investment programs have expanded over the years, with the latest one closing at $620 million – a $389 million main fund and $230 million in sidecar and segregated accounts. 

Ten global pension funds and asset managers – such as Canada Pension Plan Investment Board, Australia’s Hostplus, and Ardian – now participate in the Hermes platform. It reflects growing LP interest in accessing direct deal flow or escalating existing co-investment programs. 

“We partner with like-minded institutions that have primary fund commitments but don’t have co-investment execution capability. They can share their deal flow with us, and we can help drive the deal sourcing and improve the quality of the portfolio,” says Iesan Tsai, head of Asia at Hermes. “We see them as partners from the beginning, not just providers of capital.” 

While co-investing with a portfolio GP reduces the fee burden of the overall relationship, Hermes sees three other key advantages: it allows control of the asset, it mitigates the j-curve effect, and it represents an opportunity to boost exposure to certain sectors. 

The group has invested in more than 250 PE funds and 180 made co-investments globally. The goal is to maintain an even split between fund commitments and co-investments, but the latter accounts for more than half of Hermes’ $7 billion in assets under management. About 20% of the overall portfolio is deployed in Asia.

Deal-by-deal

Hermes opened its first Asia office in Singapore seven years ago, although the group has been investing in the region since the 1990s. With an on-the-ground presence, the co-investment strategy has developed considerably, resulting in an emphasis on identifying high-quality newly-established GPs that can drive deal flow. 

“We previously focused more on large-cap regional GPs due to global oversight and their institutional standards of practice, but now we see many high-quality spin-off teams in the region as well,” says Tsai. “They are smaller than the large buyout players, but they often outperform their peers.”

The sweet spot is middle-market buyouts, with fund or co-investment commitments of $10-$60 million. Hermes is comfortable backing first-time funds and also differentiates itself from many other LPs by taking part in co-investments with fund-less sponsors. This is seen as a relationship building process that may result in a blind pool commitment. 

Capital Square Partners is a case in point. The Singapore-based buyout manager was operating on a deal-by-deal basis when it teamed up with Hermes on an investment in Minacs, an India and US-based business process outsourcing (BPO) services provider, alongside CX Partners. The company was sold two years later. Hermes has since done two more co-investments with Capital Square and also anchored the firm’s debut fund. 

Tsai has seen the deal-by-deal model catch on in markets beyond Asia, estimating that almost half of first-time GPs globally are executing transactions on this basis. “In the past, deal-by-deal could imply a GP did not have the ability to raise a blind pool fund, but that’s no longer the case because the economics for this model can be attractive to sponsors and LPs. We’ve seen high-quality deal flow from our existing GP relationships, but we aren’t limited to making co-investments through those relationships,” she adds. 

Hermes has constructed a diversified Asian portfolio in sector terms, although there is a strong interest in education in Southeast Asia – a function of businesses being largely stable, cash-generative, and closely-wedded to rising household expenditure by the region’s nascent middle classes. At present, slightly less than a half of Asian allocation is invested in Southeast Asia, followed by South Korea, China and India. 

“The conventional view is that Southeast Asia’s blind pool funds have underperformed due to the shallow pool of GPs, but we like the market because of its specific challenges. There are language and cultural barriers, funds are smaller, and there is inefficiency in terms of intermediation. It’s easier for us to find clear market leaders compared to China and India, where you have five top players in each industry and you have to ride on the right one,” says Tsai. 

Around the region

This lack of intermediation is also present in South Korea’s mid-market space. Entrepreneurs don’t necessarily understand how to interact with PE investors but yet there aren’t the same negative connotations attached to the asset class as in Japan. Tsai is also concerned about valuations in Japan’s middle market, noting that a lot of deals are corporate divestments and therefore subject to auction processes. 

In India and China, meanwhile, Hermes is curbing its exposure. The allocation to India, once 30%, now stands at 10%. The group also previously participated successfully in a handful of large buyouts in China, but even though these deals are becoming more readily available, valuations are a sticking point. In the absence of an attractive entry valuation – ideally in the mid-single digits – Hermes tends to walk away.

“The trend is towards minority growth investments in the TMT [technology, media, and telecom] space. We see some firms trying to ‘ride the red dragon’ and chase VC-type of returns, but we’re less certain about the sustainability of this trend so we haven’t pursued it heavily. We make minority growth investments in traditional industries in China, and we look for targets that have tech-enabled strategies,” says Tsai.   

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• Topics
• LPs
• Fundraising
• Buyouts
• Fund-of-funds
• Hermes GPE
• Co-investment
• Asia