Private Capital Investing Part 1: Introduction to Private Capital BY Jonathan Firestein, Managing Director, Private Capital Sean Olesen, CFA, Director, Private Capital
Private Capital Investing Part 1: Introduction to Private Capital BY Jonathan Firestein, Managing Director, Private Capital Sean Olesen, CFA, Director, Private Capital Private Capital is a broad label applied to any private investment fund that invests in the equity or debt securities of privately held companies, real estate and other real assets. Introduction to Private Capital will define the asset class, highlight key elements of the Private Capital investment experience, and discuss the benefits and risks of Private Capital investing. We will share our approach for selecting Private Capital investment strategies and managers and provide guidance for participation in the asset class. We believe our approach, combined with our lack of conflicts, positions our clients for strong performance from exposure to the Private Capital asset class. Private Capital is a dynamic investment practice in which more than money is invested. Compared to investors in public companies, Private Capital fund managers typically take a much more active role in the management of the companies and assets in which they invest. Private Capital fund managers often contribute to business strategy and can play a part in directly managing assets. The ultimate goal is to create value by improving operations, strengthening the management team, fortifying the capital structure, and bolstering the strategic position of the companies and assets in which they invest. To accomplish these objectives, Private Capital investment strategies are typically multiple years in duration. Private Capital is a dynamic investment practice in which more than money is invested. Private Capital is generally considered to be a high-returning asset class that may enhance the overall return and help to smooth the performance of a well-diversified investment portfolio. Private Capital returns can exhibit low correlation to returns from other asset classes, such as stocks and bonds. Investors may consider Private Capital for a portion of their wealth which does not require daily liquidity. These attributes of Private Capital come with commensurate risks. At any given time there are well over one thousand Private Capital managers raising funds across numerous investment strategies and geographies. Recommending Private Capital investment opportunities involves navigating a complex world of potential conflicts that can influence an investment advisor. Manager selection bias, driven by embedded conflicts, may directly impact the recommendations an advisor offers to clients. 1
Insights Private Capital Investing At Ascent Private Capital Management of U.S. Bank ( Ascent ), the foundation of our Private Capital manager selection process is our Relative Value Assessment of global Private Capital opportunities. Our recommendations of funds which may be suitable for client portfolios are made without manager selection bias, as we have consciously set up our organization to be free of the embedded conflicts an advisor faces in selecting Private Capital managers: No fee sharing with any manager - if an analyst can only choose from managers that will share revenue with the wealth management platform, then many good managers are left out of the search. No internally managed feeder funds with an extra layer of fees. No management of proprietary funds - we do not directly manage any Private Capital strategies, thus we are not biased to recommend our own strategies over others. No investment banking teams promoting investment from wealth management clients to attract investment banking clients. No analyst compensation is linked to the level of client investment in funds we recommend. At Ascent Private Capital Management of U.S. Bank ( Ascent ), the foundation of our Private Capital manager selection process is our Relative Value Assessment of global Private Capital opportunities. We believe awareness and evaluation of cyclical and secular economic trends, in addition to intelligent manager selection, helps drive long-term performance success in Private Capital. Our team of Private Capital investment analysts searches the universe of Private Capital managers and strategies for what we believe are the most compelling investment opportunities for clients, without manager selection bias. The absence of conflicts in our manager selection process enables the most complete access to the Private Capital manager universe. Private Capital managers want to work with Ascent clients for many reasons. Clients of Ascent are clients of U.S. Bank, which has a 120+ year history and today is the nation s 5th largest commercial bank. Ascent exclusively serves families with a net worth above $25 million and many families have wealth in excess of $100 million. Ascent clients are perceived as long term investors, as they typically have multi-generational investment horizons measured in decades. Private Capital managers understand our interest in their fund to be without conflicts and purely investment related, as we do not propose to split fees with the manager, form feeder funds to charge our clients for access, manage any competing strategies or staple our client s interests to investment banking activities. 2
Private Capital Strategies Private Capital investment strategies are numerous and diverse in style and geography. Private Capital fund managers generally concentrate on a particular investment strategy in which the fund manager has significant experience. The three distinctive Private Capital asset groups each have a number of investment strategies: Private Equity strategies invest in equity and debt interests in privately held companies, ranging from the first funding of a startup to buyouts of multi-billion dollar companies. Real Assets strategies acquire and manage real estate, production assets and commodities. Special Situations strategies pursue companies, assets and owners of assets that have elements of distress or opportunities to participate as a minority investor. Private Capital investment strategies are numerous and diverse in style and geography. The universe of Private Capital investment strategies is represented on the chart below. Detailed descriptions of each Private Capital investment strategy are located in the Appendix which follows this paper. Private Equity real assets Venture Captial Buyouts Private Debt Special Situations Private Real Estate Real Assets Early Stage Mega Corporate Secondaries Office Infrastructure Traditional Venture Growth/ Expansion/ Late Stage Large Middle Market Lower Middle Market Real Estate Venture Royalities Asset Based Lending Distressed Debt Co-Investments Turnarounds Industrial Retail Hotel Multi-Family Specialty Oil & Gas Timber Farmland Water Rights Metals & Mining Power Generation Luxury Goods Each investment strategy within the three asset groups is unique for its focus, target assets, and the applied skill set of the fund manager. For example, the method in which an early stage venture capital fund manager creates value is distinctly different from that of a traditional venture or later stage venture capital fund manager. 3
Insights Private Capital Investing Private Capital assets are typically acquired and held by a limited partnership, a legal entity created and managed by the fund manager and owned in aggregate by all investors participating in the partnership. Investment Structures Private Capital assets are typically acquired and held by a limited partnership, a legal entity created and managed by the fund manager and owned in aggregate by all investors participating in the partnership. Private Capital limited partnerships may offer exposure to one investment ( Direct ), a portfolio of investments ( Fund ), or a fund of multiple portfolios of investments ( Fund of Funds ). Each offers varying levels of risk and diversification, as identified in the chart below. RISK Lower Moderate Higher Fund Structures Direct I Investor Fund I Investor Fund of Funds I Investor FoF Fund of Funds F Fund F F F Fund A Assets A Assets A A A Assets Fund Characteristics 1 Asset No diversification Asset selected by investor Single layer of fees 10-25 Assets Moderate diversification Fund selected by investor Assets identified by manager Single layer of fees 100-300 Assets Substantial diversification Investor selects fund of funds manager Fund of funds manager selects allocation to funds Selected fund managers identify assets Double layer of fees 4
Manager Selection Process Private Capital investors can search for new investments by looking for good managers or can drive a search based on identification of a compelling Private Capital sector, a term applied to an investment strategy in a particular geography. Private Capital sectors can be affected significantly by cyclicality or the state of capital markets. It is unlikely that a good manager s fund will outperform expectations when the sector in which the manager invests was not compelling at the time that particular fund was investing. Our approach is to identify attractive sectors first. Our research team covers dozens of distinct Private Capital strategies in domestic, developed international and emerging markets. At any given time some of the sectors appear to be more compelling than others, and some do not look compelling at all. Once we have determined that a particular sector is compelling, we then perform analysis to help identify the best positioned manager to pursue the investment opportunity for our clients. Bad Manager Median Manager Good Manager Bad Sector Median Sector Good Sector Aim Here We believe timely selection of investment strategies and fund managers, combined with thorough due diligence, can significantly contribute to the potential for strong realized returns. The process of identifying attractive Private Capital sectors begins with our Relative Value Assessment, in which we compare all Private Capital strategies to each other and seek to identify the strategies that offer the most compelling risk-adjusted return potential. The objective of our sector first approach, driven by our Relative Value Assessment of Private Capital sectors, is to outperform market benchmarks. We believe timely selection of investment strategies and fund managers, combined with thorough due diligence, can significantly contribute to the potential for strong realized returns. Intelligence for our Relative Value Assessment comes from three sources manager meetings, metrics, and our perspective on the global macro environment. Manager meetings provide opportunities to learn about an individual manager and assess the investment opportunity set. At what level are assets priced? How much competition is there for deals? Is financing cheap and easy or difficult and expensive to obtain? Are strategic buyers active? What are the manager s expectations for growth? How will the manager add value to the asset? When does the manager expect to exit the investment? In addition to learning about a manager s competitive advantage, we are closely concerned with the current deal environment in which our clients can participle. 5
Insights Private Capital Investing We will not recommend a Private Capital investment until we have identified and analyzed known and conceivable risks. Private Capital metrics are industry-specific measures where we can compare current and past market conditions to determine, among other things, if deals being done in today s environment are cheap or expensive, more or less levered, and offer high or low return potential. The goal is to develop an opinion on the riskiness of today s deal environment versus other time periods. For example, one metric applied in evaluating opportunities in leveraged buyouts is the enterprise value (the total value of a company s equity and debt less cash) multiple of current cash flow. Historical valuation multiples exist within a defined range, but are higher at market tops than during recessions, reflecting possible optimism versus pessimism and the likely aggressiveness of lenders to buyout deals. In general, we want to buy when enterprise value multiples are not near the top of the historical range. An example metric we monitor in real estate is the capitalization rate. This is the relationship between the annual net operating income (revenue less expenses before debt service) produced by a real estate asset and the cost to acquire it. In general, we want to buy when capitalization rates are higher rather than lower. Evaluating the global macroeconomic environment is an important consideration when making a Private Capital investment. Successful identification of long term secular trends can lead to strong performance. For example, investing in venture capital as the internet was becoming ubiquitous in the 1990s was extremely profitable for many investors. Understanding the effects of low interest rates and plentiful financing on commercial real estate during the 2002 through 2007 period was also profitable for many investors. A commitment to a Private Capital fund is the belief that the attractive market conditions observed today will stay intact for years into the future. We are well aware that being late to a secular trend can be very risky, as evidenced by the technology bust of 2000-2002 and the real estate bust of 2007-2009. When we have identified a particular Private Capital investment strategy we believe is compelling, we pursue meetings with many managers to assess our choices for investment. After selecting a few finalists, we perform significant due diligence which includes a robust review of the fund structure, firm, people, investment terms, portfolio construction, various operational and strategy-based risks, strategic partners (auditors, legal counsel, etc.) and the historical performance of previous funds. We call references, people we know as well as names provided by the manager. We perform an operational risk assessment, looking into all of the activities of the firm to determine whether it is suited to manage the fund proposed. We also consider the tax and legal ramifications of investing in the fund. We will not recommend a Private Capital investment until we have identified and analyzed known and conceivable risks. Building a Globally Diversified Private Capital Portfolio Building a diversified Private Capital investment portfolio can require years of development. It is possible to diversify Private Capital exposure by investment strategy, geography, manager, and vintage year (the year in which a fund makes its first investment). Many investors attempt to diversify their total investment portfolio by utilizing Private Capital to invest in 6
strategies, assets and areas where they currently have either limited or no exposure through a traditional public market-focused investment portfolio. Capital Commitments An investment in a Private Capital fund requires making a commitment to invest capital through the investment period of the individual fund (typically 2 5 years). There can be a considerable lag between the time of the capital commitment and investment of committed capital. Funds have multi-year investment periods, and some Private Capital investment strategies make only a few investments per year. In addition, total invested capital falls when funds sell assets and distribute capital back to investors. In many funds, substantially less than 100% of an investor s commitment will ever be outstanding. Thus, reaching a target allocation to Private Capital requires time and careful planning, to avoid remaining under or over the targeted exposure for an extended period of time. Benefits / Risks to Private Capital Like any investment strategy, Private Capital investing has unique benefits and risks. Investors may be attracted to Private Capital for a number of reasons including the potential for high returns relative to comparable public market opportunities, low performance volatility and low correlation to traditional assets such as stocks and bonds. Private Capital may further diversify investment portfolios by providing access to assets not found in the public markets and an opportunity to make investments that correlate with long-term secular themes in which an investor believes. Many Private Capital fund managers have significant organizations and long histories of creating substantial value in the assets they acquire....reaching a target allocation to Private Capital requires time and careful planning, to avoid remaining under or over the targeted exposure for an extended period of time. However, there is the risk that the aniticipated investment experience is not realized by each Private Capital fund. In a long term investment strategy with illiquid assets, even the best intentions can go unrewarded. Market conditions change, asset values can decrease, and investment strategies that looked prudent when executed can turn out to be less than ideal as time passes. Interests in a Private Capital fund are also generally subject to restrictions on transferability and resale. Clients Interests Come First Ascent clients are in a position to realize the potential benefits of investing in the Private Capital asset class, due in part to our conflict free approach and our ability to help clients invest in what we believe to be well positioned Private Capital investment opportunities. Wealth management platforms can be riddled with conflicts when making recommendations. Any platform that is compensated by the fund manager for raising capital or by structuring a feeder vehicle with which to direct client capital to a specific fund has bias to select the manager that will pay the highest fee. Wealth management platforms within investment banking firms may be motivated to recommend firms where they have existing relationships that produce fees. These same firms may recommend proprietary strategies managed by 7
Insights Private Capital Investing Our Private Capital investment platform is the product of our best ideas without any embedded conflicts that may hinder our ability to select Private Capital funds for Ascent clients. their firm, likely earning their firm more than they could if they recommended outside firms. Additionally, any research analyst whose compensation is tied to the level of investment in funds on which they work is motivated to drive high investment levels, regardless of the relative attractiveness of the strategy or manager. These inherent conflicts of interest do not exist at Ascent. Global Opportunistic Private Capital We have high conviction in the Private Capital asset class, our relative value approach to identifying managers in attractive sectors, our access to top tier managers we identify through rigorous due diligence, and our conflict free approach. Our mission is to provide clients with suitable, long term, diversified, global exposure within the Private Capital asset class. Our Private Capital investment platform is the product of our best ideas without any embedded conflicts that may hinder our ability to select Private Capital funds for Ascent clients. 8
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Appendix Private Capital Investing Private Equity Private Equity invests in equity and debt interests in privately held companies, ranging from the first funding of a startup to buyouts of multi-billion dollar enterprises: Venture Capital: investments in companies pursuing development and expansion of a product or service. - Early Stage: young companies with little to no revenue, some with a finished product prototype or service model - Traditional Venture: companies requiring capital for commercialization of a new product or service - Growth / Expansion / Late Stage: expansion of operations and manufacturing, typically in preparation for an initial public offering or sale to a strategic buyer Buyouts: acquisitions of controlling interests in mature, profitable companies. - Lower Middle Market: companies with total enterprise value (equity value plus debt minus cash) of less than $100 million - Middle Market: companies with total enterprise value between $100 million and $500 million - Large: companies with total enterprise value between $500 million and $2 billion - Mega: companies with total enterprise value greater than $2 billion Private Debt: secured and unsecured debt investments in companies and assets - Corporate: companies seeking secured or unsecured debt - Real Estate: financing for the acquisition or development of property - Venture: early stage companies, typically includes some form of equity participation - Royalties: income streams created by the licensing of healthcare products, mineral royalty interests or other intellectual property - Asset Based Lending: loans backed by hard assets, such as property or machinery 10
REAL ASSETS Real Assets: acquire and manage real estate, resource production assets and commodities: Private Real Estate: office buildings, industrial parks, retail outlets, hotels, multi-family residential, and specialty properties, such as student and senior housing Real Assets: non-real estate-based hard assets - infrastructure: ports, bridges, toll roads, airports, utility towers, energy midstream assets, educational and healthcare facilities, mass transit and water treatment plants - Oil & Gas: partnerships to drill for carbon-based commodities - Timber: forestland and the operations to harvest timber for sale - Farmland: farmland for managed operations and leasing to farming operations - Water Rights: properties with water rights to sell or aggregate into larger water providers - Metals & Mining: partnerships to mine for industrial and precious metals - Power Generation: coal and natural gas fired power plants, and clean energy (solar, wind, hydro) power production - luxury Goods: rare and appreciable wine, cars, and art Special situations Special Situations: companies, assets and owners of assets that have elements of distress and/or present opportunities to participate as a minority investor. Secondaries: seasoned Private Capital fund assets and direct investments, generally acquired at a discount from investors seeking liquidity Distressed Debt: debt obligations of troubled companies priced below par with insights into recovery or the objective of pursuing a change of control Co-Investments: investments alongside fund managers in single deals with attractive deal terms (typically with discounted or no management fee and carried interest profit share with the fund manager) Turnarounds: investments in troubled companies with the objective to address the cause of distress, by working with or replacing management 11
Insights Private Capital Investing 12
Jonathan Firestein holds an M.B.A., M.S. and a B.A. and has experience in private equity, merger & acquisition, wealth management and technology environments. He now serves as Managing Director, Private Capital for Ascent Private Capital Management of U.S. Bank. Sean Olesen, CFA, holds an M.B.A. and a B.S. and has experience in family office, wealth management and technology environments. He now serves as Director, Private Capital for Ascent Private Capital Management of U.S. Bank. Important DISCLOSURES This information represents the opinion of U.S. Bank and is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. Investment in Private Capital is suitable only for sophisticated investors and requires the ability and willingness to accept the risks, (including the loss of some or all of an investor s capital), lack of liquidity and a potentially long-term binding commitment, which are characteristic of these types of investments. In making an investment decision, investors must rely on their own examination of the Fund and the terms of the offering, including the merits and risks involved. Investments made by Private Capital funds are typically not readily marketable and the valuation procedures for these positions can be subjective in nature. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not responsible for and does not guarantee the products, services or performance of affiliates or third party providers. U.S. Bank and its representatives do not provide tax or legal advice. Each client s tax and financial situation is unique. You should consult their tax and/or legal advisor for advice and information concerning your particular situation. Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Not a Deposit Not FDIC Insured May Lose Value Not Bank Guaranteed Not Insured by Any Federal Government Agency 13
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