Private equity opportunities beyond the mainstream

Author: Loïc Rentiers Senior Vice President, Private Funds Group Rory McMahon Analyst, Private Funds Group PineBridge Investments, London PineBridge’s Private Funds Group (PFG) has committed over US $15 billion to private equity(1) across primary and secondary markets since 2000. Commitments include primary private market investment opportunities in key emerging regions like Mexico and Sub-Saharan Africa, as well as the more traditional developed markets. PFG also pursues complementary secondary and private credit strategies, offering substantial potential for diversification, j-curve mitigation and portfolio duration management. -

Developed and emerging market investment opportunities; in primary markets, secondary markets and private credit strategies; with a focus on under-the-radar, smaller opportunities; matched with unparalleled client service for managed account and co-mingled fund clients.

The continued success of the PFG approach is testament to the emphasis PineBridge places on meeting client expectations and treating their priorities as indistinguishable from its own. Continual client feedback is of paramount importance, serving as an invaluable tool for continued asset growth. What private equity investors want? Private capital investing is often employed as a complement to broader, traditional asset class portfolios. Private equity investors tend to seek three fundamentals; consistent and superior risk1

As of 30th June 2014.

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adjusted returns; punctual and intelligible communication; and the flexibility to accommodate individual investment requirements. As straightforward as these criteria seem, achieving these goals often proves an exacting task for private equity firms. Attaining superior performance over any significant length of time is challenging, as evidenced by the wide variance in performance across the industry. It requires a disciplined investment strategy, the experience and skill to perceive investment trends and to source opportunities, and rigorous due diligence. What Private Funds Group delivers PFG clients like the team’s extensive footprint in global markets. Even more compelling are PFG’s cutting-edge investment opportunities in geographies, strategies or market segments that fall below the typical investment radar. The investment team focuses on smaller and less covered market segments, in primary and secondary private equity and in private debt strategies. This approach is particularly applicable in the current economic climate. Strong public markets and large volumes of dry power(2) (capital which has been committed by investors but has yet to be invested) have fuelled high purchase multiples at the larger end of the market, meaning that above-average returns are harder to come by. While a focus on creating added value through operational or management improvements is an essential component of private equity, higher entry multiples substantially increase the risk profile. Operational improvements would struggle to compensate for a sizeable contraction of multiples, especially if the situation is compounded by the high levels of leverage often seen in the large end of the market. Figure 1 shows how competition for the larger, more visible assets has resulted in a tangible impact on valuation multiples.

Fig.1 Source: Pitchbook, ‘3Q 2014 Global PE Deal Multiples and Trends’, September 2014.

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Bain and Company, ‘Global Private Equity Report 2014’, March 2014.

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A bigger selection of smaller opportunities Entry multiples have expanded by far less in the small and middle segments of the market where deal sizes range between US $5-50m and fund sizes are approximately US $250m-$1bn3. As competition for deals appears less fierce, the PFG strategy targets value-driven opportunities more effectively than strategies that follow the herd. There are also far more companies with solid prospects at the smaller end of the spectrum. This segment is forecast to see significant revenue increases in 2014, with top-line growth projected at 5.8% in the United States over the next 12 months(4). Europe is best assessed on a market-by-market basis. Middle-market revenues in the UK and Germany are predicted to grow by an impressive 6.1% and 4.8% respectively in 2014. And even countries that concern economic pundits can deliver: France, for instance, is on track for 3.4%(4,5). Small- and mid-markets in developed economies also offer substantial potential for operational improvements through direct changes and management team strengthening, buy-and-build investments and geographic and product line expansion. Larger companies often already have more professional management in place, limiting the levers of change. Beyond the developed universe Drivers and levers differ considerably between developed and emerging markets. Developed market small-and mid-sized investments are generally driven by operational improvements and an institutionalized market environment. Emerging markets offer the opportunity to benefit more directly from underlying economic growth. Mexico, the Andean region of South America and Sub-Saharan Africa (SSA) are prime examples. Each is experiencing rapid economic growth and favourable economic fundamentals. They all have positive demographics and are enacting political and structural reforms to buttress sustainable growth. From a private equity perspective, these regions have a cornucopia of companies that could benefit from the growth capital and the operational expertise that private equity brings, yielding a favourable return for investors. These still immature private capital markets are at an attractive inflection point. Investors are keen to join with PFG, in partnership with local management teams, to participate in these businesses’ strong anticipated growth phases over the next decade, and to earn attractive alpha as a result.

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Pitchbook, ‘3Q 2014 Global PE Deal Multiples and Trends’, September 2014. National Centre for the Middle Market, ‘2Q 2014 Middle Market Indicator’, June 2014. 5 GE Capital, ‘The UK Mid-Market: Pivoting to Growth’, June 2014. 4

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Minimising risks Operating with businesses at the small end of the market entails risk, of course. Limited partners need to be comfortable that the team they are investing in has appropriate systems in place to minimise that risk and to offer favourable risk-adjusted returns. The PFG team subjects each opportunity to rigorous risk analysis and sensitivity testing applying a proven analysis framework developed and tested over more than 14 years, and several cycles, of private market investing. In broad terms, PFG’s due diligence focuses on investment strategy, track record, investment process, management team and organization, as well as proposed terms and conditions. In addition, PFG’s in-house finance and compliance teams support PFG in carrying out a comprehensive operational review, including a focus on valuations, reporting, service providers, cash management, and legal and compliance functions. The team also routinely commissions background checks on the management companies and key principals it invests with. For secondary transactions, the team models the future value of each individual portfolio company using conservative estimates, guidance from the general partner and the collective team’s considerable private equity experience as part of the extensive due diligence and underwriting process. The process is designed to establish whether each investment case is able to withstand an adverse turn in the market, and helps ensure that pricing is an effective mitigant of any future risks. Minimising manager risk A flat investment structure is always welcome, but concentrating management in the hands of the individual is not. At PFG, responsibility and investment acumen runs through the entire team. For all transactions across primary, secondary and credit vehicles, the final stages of due diligence require a review and internal approval by the entire group, not just a sign-off by the Investment Committee. Each team member crosschecks the data and analysis provided to ensure both accuracy and a consensus on the key drivers within the portfolio. This further increases the likelihood of a successful return on each investment and reinforces knowledge transfers among the team. A suitable horizon The speed at which money is returned is as important a factor as the overall return when evaluating a prospective manager. Shorter time horizons need not mean a significantly lower expected return. The oft-noted disadvantages to investing in private equity are the typically long lockup periods and ensuing lack of liquidity. A strategy pursuing mature companies with high visibility, like that employed by our secondary vehicles, may be highly attractive to certain investors. By investing in mature assets that are likely to exit in the near term, it is possible to dramatically reduce the holding period and provide positive cash flows in a much shorter time horizon. With a higher Internal Rate of Return (IRR), these strategies also mitigate the j-curve effect by reducing the

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period during which an investor experiences net negative cash flows. Likewise, private credit investments can mitigate the j-curve through cash yield and shorter overall investment duration. The known maturity profile of underlying investments also positions private credit as an excellent tool for overall portfolio duration management. As a result of this investment strategy focused on the lower end of the market and integrated processes, PFG has achieved consistently strong returns across all of its primary, secondary, and credit portfolios, with over 85% vehicles since inception being top quartile.6 That ability to generate alpha is a comfort to investors that the investment model is sustainable. A focus on client service Private equity information and reporting needs have grown in importance and complexity over the past decade. Investors are increasingly sophisticated and regulatory requirements have increased the reporting workload. A dedicated client services team is absolutely crucial to serving these information needs and to fostering trusting relationships. One of the benefits of a dedicated client team is that it ensures that the firm can truly understand the objectives of the investor and consider how best to meet them. However, firms that manage to build a relationship with their clients often lack the flexibility to fully make this work to the client’s advantage. Without the ability to offer specific arrangements such as separately managed account solutions, it can be impossible to appropriately tailor services to the investor’s individual goals and requirements. PFG recognises that it is frustrating for clients to have to jump through administrative and bureaucratic hoops to receive information about their investment performance, portfolio composition, governance, or any other relevant features of their investment. To cater for individual requirements, PFG assigns a dedicated relationship manager to each individual limited partner. The relationship manager is the client’s day-to-day point of contact from the inception of the relationship, providing on-going service and delivering timely solutions to any matter that that may arise. This manager serves as the client’s advocate internally, partnering with the investment team to ensure that requirements and services are appropriately implemented and met. The aim is to deliver complete transparency between the firm and the client. PFG actively ensures that all its reporting and limited partner communications meet the standards and best practices set out in the ILPA guidelines, among others. Crucially, the client relationship manager is able to understand the unique needs of individual limited partners and proactively cater for them. These may range from accommodating specific reporting needs by providing personalised analysis to guidance from our in-house Chief Economist Markus Schomer. And of course, PFG client managers can make introductions to other PineBridge

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Data as of 31st March, 2014. Quartile rankings for all vehicles are based on ThomsonOne/Venture Economics Cumulative Vintage Year Performance for “All Global Private Equity Partnerships”.

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asset class teams and expertise should clients wish to diversify their alpha-generating opportunities. SMA or co-mingled? A complete investment solution for limited partners must be flexible and tailored. PFG can provide separately managed accounts (SMAs) for clients who wish to fully customise their investment portfolio or who have specific needs or tax considerations. Through its global, integrated platform, PFG has extensive product and regional expertise in relation to on-boarding and SMAs structuring. Excellent relationships with the major custodian banks ensure a smooth and expedient implementation. Co-mingled products are still a viable alternative for investors looking to deploy smaller amounts of capital into private equity, or to complement existing, directly managed core allocations. To enable smaller investors to tailor their exposure to individual needs, PFG’s comingled products allow investors to choose between, and select, weights among a wide range of underlying strategies. Moreover, PFG’s co-mingled offerings also include products focused on cutting edge strategies and regions that cater to the needs of a smaller, more sophisticated group of investors. Whether an SMA or co-mingled fund client, a strong and symbiotic relationship is key. Across the asset management industry, over 60% of clients cited trust, or lack thereof, as the major factor in their decision to terminate an investment advisor relationship(7). Strong performance no longer appears sufficient to persuade private equity clients to recommit the next time a firm fundraises. Beyond investment results, which will of course always remain a crucial ingredient, factors such as the manager’s degree of institutionalization, the investment strategy’s consistency and replicability, as well as the management team’s stability and treatment of its clients are key ingredients to establish trust in PFG’s experience. Establishing trust is of particular importance in private equity due to its long term focus, with limited partnership structures usually aligning managers and investors for a horizon of at least ten years. Future-proof The evolving demands of limited partners have driven major changes in private equity in recent years, from fee structures to reporting levels. We believe that they will continue to shape the future of the industry. Our focus on absorbing the feedback from our investors and providing consistently superior client service stems from this belief. From a client service perspective, it is inevitable that technology will play an ever increasing role in private equity. The importance of face-to-face contact remains undiminished, yet most investors are consumers of high-end technology and will at some point expect a joined-up service with seamless access to accounts and information across multiple channels. For this reason, PFG will endeavour to maintain a clear focus on providing information via state of the art technology solutions. 7

North American professional Liability Insurance Agency, ‘Investment Advisor Series: Using your insurance as a marketing tool’, December 2013.

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In terms of investment strategy, limited partners continue to look for attractive returns beyond the traditional European and North American markets. While Europe has experienced a recent revival as economic fundamentals improve and stabilize, it is emerging market countries that are piquing investor interest. But none of the BRIC countries feature in the top three markets (as measured by limited partner interest) for the first time in nine years(8). These former favourites had been usurped by enticing growth stories coming from Sub-Saharan Africa, the Andean region of South America and South East Asia(9). Profitable investment opportunities will flow for those who are able to pre-empt the changing tides and recognize that many market dislocations and inefficiencies have a limited time-horizon. PFG has a long history of alpha-generating private equity firsts. These include the first dedicated credit fund to take advantage in the collapse of traditional credit availability in the wake of the Financial Crisis, to the first ever listed Mexico private fund vehicle, launched in 2011. Regulatory developments will also continue to shape the private equity industry for years to come. The Alternative Investment Fund Managers Directive came into force in Europe last year. The Security Exchange Commission continues to scrutinize the possible taxation of carried interest. Whatever the outcome of this and other regulatory and legislative moves, the vast majority (83%)(10) of the industry’s CFOs polled felt that there would be an increase in costs, interestingly particularly from a limited partner perspective, just 15% felt that this would be likely to lead to lower returns(11). The difference between these two figures suggests that private equity firms do not envisage being able to pass on these costs to their investors. They will have to absorb them instead, likely receiving lower after-tax remuneration. Despite the vociferous complaints of a few industry pundits, most industry participants cautiously accept these changes. As a group, PFG continues to implement responsible investment principles and stringent transparency requirements as part of its business and operational due diligence. It is our view that such policies ultimately add value to our portfolio and help forge stronger relationships with our clients.

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EMPEA, ‘Global Limited Partners’ Survey, 2013. Bain & Company, ‘Global Private Equity Report 2014’, March 2014. 10 E&Y, ‘Navigating the Headwinds: 2014 Global Private Equity Survey’, 2014. 11E&Y, ‘Navigating the Headwinds: 2014 Global Private Equity Survey’, 2014. 9

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Disclosure Statement PineBridge Investments is a group of international companies that provides investment advice and markets asset management products and services to clients around the world. PineBridge Investments is a registered trademark proprietary to PineBridge Investments IP Holding Company Limited. For purposes of complying with the Global Investment Performance Standards (GIPS®), the firm is defined as PineBridge Investments Global. Under the firm definition for the purposes of GIPS, PineBridge Investments Global excludes some alternative asset groups and regional legal entities that may be represented in this presentation, such as the assets of PineBridge Investments. Readership: This document is intended solely for the addressee(s) and may not be redistributed without the prior permission of PineBridge Investments. Its content may be confidential. PineBridge Investments and its subsidiaries are not responsible for any unlawful distribution of this document to any third parties, in whole or in part. Opinions: Any opinions expressed in this document may be subject to change without notice. We are not soliciting or recommending any action based on this material. Risk Warning: All investments involve risk, including possible loss of principal. Past performance is not indicative of future results. If applicable, the offering document should be read for further details including the risk factors. Our investment management services relate to a variety of investments, each of which can fluctuate in value. The investment risks vary between different types of instruments. For example, for investments involving exposure to a currency other than that in which the portfolio is denominated, changes in the rate of exchange may cause the value of investments, and consequently the value of the portfolio, to go up or down. In the case of a higher volatility portfolio, the loss on realization or cancellation may be very high (including total loss of investment), as the value of such an investment may fall suddenly and substantially. In making an investment decision, prospective investors must rely on their own examination of the merits and risks involved. Information is unaudited, unless otherwise indicated, and any information from third party sources is believed to be reliable, but PineBridge Investments cannot guarantee its accuracy or completeness. PineBridge Investments Europe Limited is authorised and regulated by the Financial Conduct Authority (“FCA”). In the UK this communication is a financial promotion solely intended for professional clients as defined in the FCA Handbook and has been approved by PineBridge Investments Europe Limited. Should you like to request a different classification, please contact your PineBridge representative. Approved by PineBridge Investments Ireland Limited. This entity is authorised and regulated by the Central Bank of Ireland. In Australia, this document is intended for a limited number of wholesale clients as such term is defined in chapter 7 of the Corporations Act 2001 (CTH). The entity receiving this document represents that if it is in Australia, it is a wholesale client and it will not distribute this document to any other person whether in or outside of Australia. In Hong Kong, the issuer of this document is PineBridge Investments Asia Limited, licensed and regulated by the Securities and Futures Commission (“SFC”). This document has not been reviewed by the SFC. PineBridge Investments Asia Limited holds a Representative Office license issued by the Central Bank of the UAE and conducts its activities in the UAE under the trade name PineBridge Investments Asia Limited– Abu Dhabi. This document has not been reviewed by the Central Bank of the UAE nor the SFC. In the UAE, this document is issued by PineBridge Investments Asia Limited – Abu Dhabi Representative Office. PineBridge Investments Singapore Limited is licensed and regulated by the Monetary Authority of Singapore (the ”MAS”). In Singapore, this material may not be suitable to a retail investor and is not reviewed or endorsed by the MAS. PineBridge Investments Middle East B.S.C.(c) is regulated by the Central Bank of Bahrain as a Category 1 investment firm. This document and the financial products and services to which it relates will only be made available to accredited investors of PineBridge Investments Middle East B.S.C. (c ) and no other person should act upon it. The Central Bank of Bahrain takes no responsibility for the accuracy of the statements and information contained in this document or the performance of the financial products and services, nor shall it have any liability to any person, an investor or otherwise, for any loss or damage resulting from reliance on any statement or information contained therein.

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