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Horizons: Family Office & Investor Magazine

Rolf Dreiseidler: Winners and Losers of the Pandemic

Monday, September 21, 2020

Rolf Dreiseidler is a Managing Partner of POLARIS Investment Advisory. Rolf has also been Co-Chairman of the German Alternative Investment Association (BAI) for over ten years. POLARIS operates out of Zurich and London, focusing exclusively on Alternative Investments. As one of the most successful placement agents serving global GPs targeting European Institutional Investors, Rolf and his colleagues have first-hand witnessed how the COVID-19 pandemic has changed the investment and fundraising business and who comes out as a winner of this.

Matthias Knab: Rolf, from your perspective as a promoter of global funds to European institutions, who are the winners and losers of the pandemic when it comes to fund raising?

Rolf Dreiseidler: Allow me to start where things are on our end: I actually believe that 2020 is going to be one POLARIS’ best years ever. How is this possible? Well, it’s a combination of things that played out in our favor. Clearly, most if not all of the tickets that came in Q1 and Q2 2020 were on the back of a lot of work that we had done in 2019 already. When the lockdown was initiated and LPs were neither able to travel nor to meet GPs in their offices, the investors’ focus was put on those asset managers that they have met before and that they have already done some Due Diligence (DD) work on. In some instances COVID-19 really accelerated the DD processes and decision making due to the uncertainty about the duration of the lockdown. LPs really wanted to get these deals done. What also helped us a lot is the outstanding quality and the differentiated strategies of the asset managers we currently work with that resonate very well with our investor base.

For example, a few years ago we have realized that LPs are in general underweight Asia in their Private Equity programs. However taking into consideration how economic growth has shifted over the past decade as well as how institutionalized Asian Private Equity has become during that time period, we felt that there is a gap to be filled. We had – and still have – the honor to partner with the leading pan-Asian Private Equity Fund of Fund to address this gap. This GP has delivered outstanding performance over all vintages and we are seeing an enormous demand from institutional investors all over Europe – even from those that typically pick Private Equity Single Funds themselves.

On top of this, we continue to see demand for solutions in corporate direct lending as well as infrastructure at the lower end of the risk/return spectrum.

Matthias Knab: This sounds great, but I wonder, is it all that rosy? And what about the challenges LPs are facing now?

Rolf Dreiseidler: You are right, there are also quite a few investors that have put their investment programs on hold since the lockdowns were introduced and markets corrected. Reasons included the lack of risk budgets due to losses in public market investments, restrictions to travel and therewith to conduct onsite Due Diligence or simply to allow for time to analyze and re-assess the developments and attractiveness of certain asset classes. This clearly put the brakes on a lot of fundraises with first closes being postponed, fundraising periods extended, etc.

Furthermore, for those investors that continued investing, the focus shifted even more to existing relationships. There has been a general trend over the past few years to sort of limit the GP- relationships due to the workload involved when approving a new GP vs. investing into a new program of a GP that the investor has previously invested with. Due to limitations to travel and therewith to conduct proper onsite Due Diligence this trend has even strengthened. This is clearly not a positive for fundraising with GPs not yet established in the market.

Matthias Knab: From your experience, are all Alternative Investment segments affected by this the same way or do you notice differences?

Rolf Dreiseidler: Our observations are that Private Equity was least affected, i.e. in general investors rather tried to continue their investment programs as for most of them PE has been the major source of outperformance over the past decade. However, there was a clear differentiation depending on how progressed the respective fundraise was. Those GPs that were rather at the end phase of their fundraising period had difficulties in getting to their target fund size. Reason being was that those managers typically have already made some “pre-Corona investments”. Investors clearly moved from a “I want to see some deals in the portfolio first” - to a “I want a fresh portfolio”-mentality, fearing that pre-Corona deals were overpriced in the new environment.

This, by the way, holds true for Private Debt and Infrastructure as well. In Private Debt we also saw that investors put their “plain vanilla” corporate direct lending programs on hold to give preference to opportunistic credit funds that seek to profit from market dislocations that started to appear in late February. Finally after many years of economic growth during which a lot of Direct Lending Funds emerged, investors wanted to see if the funds hold up to their promises in turbulent times.

Matthias Knab: And, did these funds hold up to their promises?

Rolf Dreiseidler: It might be a little too early to tell. However, the GPs we work with in that space were chosen based on their “safety-first”-philosophy, i.e. not compromising risk for higher returns. These managers showed zero to very low single digit losses for Q1 and already a recovery for Q2, so exactly in line with expectations or even exceeding expectations so far. However, in general, I expect a significant dispersion in performance to become visible in the market over the next quarters to come that will “separate the wheat from the chaff”.

Matthias Knab: How about infrastructure and also liquid Alternative Investments/Hedge Funds?

Rolf Dreiseidler: Infrastructure fundraises in general suffered a bit as well as investors started questioning the attractiveness and pricings of certain infrastructure assets including airports, harbors, toll roads etc given the potential longer-term implications of COVID-19.

As always, there are some remarkable exceptions, but generally speaking, Liquid Alternatives unfortunately have (again) not lived up to expectations during the market frictions in which they were supposed to protect the capital of their investors. It has become a very tough case for investors and consequently for fundraisers alike. With the exception of one equity long short manager, who has delivered Top 10% Performance and Sharpe Ratio over each of a 1- to 10-years rolling time period and with whom we have successfully worked together for a few years, we have taken the strategic decision to not cover the Liquid Alternatives space anymore.

Matthias Knab: In which areas do you see potential going forward so that you would be keen to add new GPs to your offering?

Rolf Dreiseidler: As a general theme we are strong believers in mid-market/lower mid-market opportunities since the larger end of the markets has been swamped by capital over the past few years. This in our view will unavoidably lead to negative implications for future performance potential. So within this lower range of the markets, we are always keen to look at Private Equity-, Infrastructure- and Private Debt-GPs that have a clear edge and a proven track record in transforming this edge into a strong performance for their investors.

Additionally, differentiation is becoming more and more of a key theme for us and our LPs. When investors started their Private Markets programs it was necessary and sufficient to have a strong pedigree and track record. Nowadays, this is still necessary but investors want to see real diversification, different sources of return to what they already have.

Imagine you already have say 15 GP relationships in US mid-market buyout. What is the value add of adding No. 16? How different can this return stream be to what you already have in your portfolio? To offer such “true diversification”, we recently partnered with a Pan-European Growth Tech Manager which focuses on B2B deep tech soft- and hardware, i.e. chips. Moving from buyout to growth already gives you very different risk-return characteristics, for example growth stage companies hardly carry any debt on their balance sheet, which is very different to buyout and can be an important factor in an economic downturn. Finally, deep tech drives our world nowadays, so we have seen strong growth of such companies and numerous deal activities in Q1 & Q2 of this year whilst buyout got under pressure all over the place.

Matthias Knab: Where else would you see growth?

Rolf Dreiseidler: Impact investing in our eyes is one of the key themes driving this decade. So we are looking for GPs that have a true focus on the ecological transition with an impact- investing-DNA; and not just a nice ESG marketing brochure. For example, we are currently negotiating a cooperation with an European leader in sustainable investments with a focus on themes like renewable energy production, energy efficiency projects and sustainable city infrastructure.

Furthermore we doing a lot of research in the field of what we call “Niche Alternatives” or “Alternatives beyond Mainstream” and we will shortly release a book on this with our insights. The idea here is that the universe of

Alternative Investments is much broader then a lot of investors are currently aware of. Typically these are areas that are not (yet) flooded with capital and that offer an outstanding potential for outperformance whilst delivering a totally uncorrelated return stream. Examples for this include music royalties, litigation financing, reg cap strategies, GP Stakes and digital assets.

Matthias Knab: That sounds quite appealing but what should investors do with this? How can this be implemented?

Rolf Dreiseidler: Investors could consider a “Core- Satellite” approach to Alternative Investing. The core within such a framework consists of the major Alternative Investment categories like Private Equity, Infrastructure, Private Debt. This could then be complemented by Satellites, which in essence form a diversified bucket of such “Niche Alternatives” with the overall goal to increase performance and diversification of the AI bucket.

Matthias Knab: What other challenges do you see for LPs and GPs in the current environment?

Rolf Dreiseidler: There will be challenges ahead for both LPs and GPs alike, which of course will consequently affect the middle-men, i.e. marketers. Many LPs plan their upcoming alternative investments around a year ahead. So, as mentioned earlier, a lot of investments that are taking place now, go back to introductions and meetings that happened in 2019 and sometimes even earlier when both LPs and GPs alike were unrestricted in travel and able to meet each other at the domicile of the investor and the asset manager.

Let’s not forget that for most investors their investment guidelines require them to meet the asset manager physically. Under the assumption that traveling will continue to be restricted for quite some time to come, LPs will eventually have worked off their pipeline anytime soon. From this point there are different paths: Either LPs will suspend their private markets programs for a while, maybe also on the back that they might not see the same level of cash returned to them from exits as before. Or they could continue with their programs but “raise the quality bar” for new investments and intensifying the Due Diligence in “non-physical”-areas.

Matthias Knab: What do you mean by intensifying the Due Diligence in “non-physical”-areas?

Rolf Dreiseidler: Let’s say an LP had the requirement to do three reference calls with other LPs as part of the Due Diligence. This number could for example be doubled to six reference calls, and/or it could be extended by not just calling other LPs for an opinion but say in the case of Private Equity, having references calls with C-level executives of portfolio companies of the GP.

In the Due Diligence of a sponsored Corporate Private Debt GP, the LP could do additional reference calls with the Private Equity sponsors to get more color on the quality of the debt manager etc.

Matthias Knab: Understood, what else is there to say about fundraising during the pandemic?

Rolf Dreiseidler: It has always been easier for the larger groups to raise assets. I believe that with the implications from COVID-19 this will be the case even more so – whilst fundraising for the smaller asset managers is going to get increasingly difficult. This will mean that such smaller GPs will have to put even more efforts into their fundraising, e.g. by broadening their regional reach-out and within regions by hardly leaving any stone unturned.

Matthias Knab: But smaller groups also have much smaller sales and relationship management teams than the larger groups, so how should they cope with this challenge?

Rolf Dreiseidler: Well, they should consider partnering with placement agents like ourselves, i.e. groups that have a demonstrable longstanding and deep network as well as a strong asset raising track-record in the markets that they cover. Such a partnership can leverage the sales capabilities of the GP by multiples.

The other thing GPs can do is leveraging of platforms such as yours at Opalesque and not only produce digital content such as videos but also gain visibility with your help. We also found that well designed webinars produced with a professional partner allows to tap into a new investor base and can be extremely helpful, particularly now when it has become very hard to start a dialogue with new prospects.

Matthias Knab: Final question: what advise would you give to GPs on how to find the right placement agent in the current environment?

Rolf Dreiseidler: Let me start by saying that the idea of just having one placement agent (PA) partner that covers the globe for you is surely tempting as it reduces the onboarding efforts like contract negotiations etc. significantly. However, I personally doubt that there is a single global PA out there that is top notch everywhere. So instead, I would rather suggest to look for regional specialists that are very dedicated in the markets that they cover and that have a proven track record of raising assets there. Such a group should be passionate about what they do, hungry to contribute to a successful fundraise, and very importantly: as a GP you should make sure that such group is willing to dedicate significant time to your fundraise. You don’t want to end at the lower end of a priority list of say 30 other fundraises supported by the PA at the same time.

Furthermore, watch out for overpromising, especially when the PA is asking for a retainer at the same time. Don’t get me wrong here, a retainer might be justified in certain cases but it has to be for the right reasons. Do reference calls with GPs that the PA has worked with previously, get to know the team and not just the lead partner. Finally, ask yourself if you feel comfortable to work with these people both from a professional but also on a personal level. It is very important that GP and PA form a good team that enjoys working together as this will reflect positively on the investors. This, by the way, should work vice versa as well. We at POLARIS had quite a few cases in the past, where we decided to reject a GP because we felt that we don’t share the same values or are not a good fit for the GP.

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