Who will survive?

From 1997 onwards, when private equity as an alternative asset class was entering a period of unprecedented growth across Europe, Swiss-based private equity fund of funds managers were making great strides. In a country famous for its private banking and asset management expertise, fund of funds vehicles were an obvious addition to the existing portfolio of investment products that could be offered to local and international clients. As David Chamberlain, managing director of the private equity arm of institutional alternative asset manager Unigestion, recalls: ?The Swiss market was driven by the fact that it is an asset management centre, born of the private banking business. There has always been a great deal of innovation, and private equity was a natural extension of that.?

The innovations included quoted evergreen structures that allowed new investors to buy into the asset class, liquidity enhancement tools and capital guarantees. Robert Nef, senior vice president at Swiss Re Capital Partners that is currently raising a second fund of funds, says that institutional interest in the asset class generally grew throughout the 1990s, and funds of funds offered a route to a swiftly diversified portfolio. He says: ?In addition, in the Swiss market, there was strong growth from innovative listed and structured products. They addressed issues of liquidity and capital protection and allowed in new investors, who otherwise would not have had the ability or the interest.?

Boom time no more
This kind of innovative thinking about private equity was underpinned by a culture of independence. Chamberlain says: ?Many of the Swiss operators are independent, truly dedicated asset management firms, not an extension of an investment bank, with their own capital at risk. There is a certain culture of entrepreneurship, dedicated to alternative asset management.? Small wonder then that the Swiss fund of funds market boomed.

But times have changed. Today Switzerland's private banking community is under siege, according to a recent report from Moody's, the credit rating agency. The insurance and asset management companies are sweating all too publicly. Swiss Life, the insurance group and private equity sponsor, was only last month forced to raise money in a rights issue that was ultimately successful, but for a while seemed anything but certain.

The country's private equity fund of funds managers have not been immune to the vagaries of the economy. All acknowledge that the coming years will be a serious test for the industry. All expect there to be blood on the floor going forward as the industry works through this period of economic pain.

?Those who ride every horse do everything and get nothing right?

Investors in private equity and venture capital of recent years have had it tough, and funds of funds, which had blossomed not only in Switzerland but also in other parts of Europe, have been hit as hard as anyone. The European fund of funds industry is certain to enter a phase of consolidation, and the Swiss fund of funds investment community, second only in size to the UK, rumbles with rumours of struggling fundraisings and managers facing an uncertain future.

The problem is that many investors have closed their wallets for the time being. Switzerland's pension fund and corporate markets are mature and saturated. Many of the listed private equity vehicles are trading at a deep discount to net asset value. And the new, often high net worth, investors that helped the Swiss market take off have also proved in many cases to be less durable than the more traditional institutional supporters of the asset class.

Performance
Recent industry talk has focused on the trials of a number of private equity practitioners who are endeavouring to steady themselves in what most see as stormy waters. One of these is Swiss Life Private Equity Partners, which is out fundraising at present. Swiss Life, its troubled insurance parent, is battling to put its own house in order after falling equity markets wiped 20 per cent off its equity portfolio in the first half of the year. It can ill afford anything other than a well performing private equity division.

Earlier this year Swiss Life Private Equity Partners took over the management of the stricken private equity investments of Private Equity Holding. PEH was originally set up and managed by Swiss private bank Vontobel, but the fund's shareholders voted to leave the bank after massive losses that lead to the sacking of three senior Vontobel executives.

David Salim, chief executive of Swiss Life Private Equity Partners, says it has taken his group about 12 months to get a good grip on the PEH portfolio, which it has now cleaned up and intends to relaunch to investors. But for most investors private equity is not on the priority list and the Swiss market is especially tough.

?Everybody is now refocusing back to core business?

Salim agrees: ?The first negative repercussions on existing products are coming to the surface. When they launched, Swiss funds of funds did not have a track record, everybody started from the same base. Now the first results are coming out and it is becoming more of an issue.? And although the special features for which the Swiss market is renowned, such as guaranteed capital returns, are important, it is performance that is increasingly coming to the fore, he adds.

Ivan Vercoutère of LGT Capital Partners, which has some €2bn of commitments to its fund of funds vehicles, agrees. He says: ?I think different groups have different levels of success. Now it is five years for most players and you can start to measure the success. Whoever comes out of the next couple of years will be here to stay.?

Investors will only want to back winners in the current environment. Salim says: ?The first cycle is finishing and a new one is starting. Some of the same brand names will be there, but re-engineered, and there will be new entrants.?

Salim is confident that Swiss Life will back his own outfit once the parent company's new management team has bedded in and sorted out the issues at group level. The importance of a diversified investment portfolio will keep Swiss Life allocating to private equity for the long-term. Meanwhile Swiss Life's first fund of funds has plenty of mileage left in it. Of the €900m commitment, around half remains to be invested, and Salim is anticipating deploying this capital in an interesting environment which should yield some good returns.

What's the winning strategy?
Other alternative asset managers though are predicted to be less fortunate, lacking a deep-pocketed sponsor with a long-term strategic interest in the asset class. As Salim puts it: ?In this market everybody is now in a phase of rethinking, refocusing back to the core business.? And Vercoutère: ?Consolidation is here, it is happening. It is not just Swiss, it is a European phenomenon in general. But there was a higher concentration of funds created in Switzerland.? Industry sources say some 15 fund of funds managers are currently active in the country. The question on everybody's lips is not just who will be left standing but how will their business have modified in the meantime.

Urs Wietlichsbach, head of markets at Partners Group in Zug, is convinced that the days of simply picking the right partnerships by doing due diligence on general partners are over. He says that what a fund of funds operator needs now is deep resources to be able to take the analysis right through to the underlying investments in individual funds to find relative value through a tactical understanding of when to do what and with whom.

Partners Group itself has a 60-strong team to throw at the task. Managing a diverse range of private equity vehicles, the group has €4bn under management and styles itself as an asset management group rather than a fund of funds manager. Along with Capital Dynamics, another Zug-based specialist, it has been at the forefront of applying securitisation techniques to private equity.

Partners Group sees itself as a natural consolidator of the segment. As the primary market is going through the motions, secondaries and restructuring are the flavours of the day. Wietlichsbach says: ?We are increasing market share by picking up restructuring mandates. Many institutional clients are looking for real investment managers to run their portfolios.? The group is committed to scouring the market to find value in secondaries. He says:?Especially in the segment of younger partnerships there isn't much competition; an experienced player who knows many managers inside out is able to buy these secondaries at attractive valuation.?

While Partners Group is relying on scale and informed opportunism to see it through what are the toughest times in the private equity market for years, other independent houses in Switzerland are playing the niche card, looking to specialise either regionally or sectorally. Some like LGT or Adveq, subscribe to the boutique is beautiful principle.

Bruno Raschle, chief executive of Adveq, pushes the point rhetorically home: ?Are you in the return game or the fee game? We are about returns. I use the term return capturing capacity. If an investor commits $1m to a $30m fund he will see more of the future returns than if he puts it into a $3bn fund.? Raschle is sceptical of the funds that try ?to ride every horse? to generate fee income: ?They do everything and get nothing right.?

Vercoutère agrees that there is a buy-the-brand mentality at work. Nobody will lose their jobs investing with one of the familiar fund of funds giants, but if the argument for investing in private equity is one of enhanced returns then putting the money with a boutique makes a lot of sense: ?€15m out of €300m is much more valuable than €15m out of €2bn. We can also invest in the big funds, so why should anyone pay just for that.?

Raschle believes that returns will be at the heart of the issue that separates survivors and losers in the Swiss market. He says: ?I fully believe there will be consolidation, but it will be around governance and a clear business mission. There will be large players and smaller players but they will be united in the alignment of interest between investors and managers.?

It is too early to tell which strategy – or strategies – will ultimately prove successful in the current market climate. What everyone in the market readily accepts though is that there are too many players and not enough business for every fund of funds in Switzerland to last through the downturn. But at the same time those who will pull through are likely to emerge stronger and ready to capitalise on new opportunities when the market, like all markets, comes back. The big question here is when.