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EXCLUSIVE INTERVIEW: Direct Investing, Lessons From Big Successes And Mistakes
22 March 2017
In the wealth management sector as in many other walks of life there is an endless quest for the "next big thing". And in a world of ultra-low interest rates where the hunt for yield is all-consuming, a trend that is gaining ground right now is direct investment. Case studies
Direct investing means different things to different people. At its simplest, it means investors decide whether or not to invest in a specific private opportunity and have an ongoing say during the ownership period. This is distinct from the typical approach which is predicated on providing investors exposure to private opportunities indirectly by having them commit to a “blind pool” fund, whose managers decide how to invest the funds, how to manage the investments and when to exit them - an investor’s only involvement is to read annual updates and wait for a distribution. Direct investing, so its practitioners say, allows wealthy investors to have transparency, higher level of control, greater engagement during the diligence and investment management processes, and better alignment of incentives between providers of capital and managers of capital.
Put differently, owners get first-hand evidence on whether an investment makes sense before their capital is deployed and can guide the investment. Family office heads also enjoy investing directly either in the same sectors in which they made their fortunes in the first place or in new sectors in which they have built conviction.
A business operating in this space and which works with family offices and large institutional investors is Tetrad Capital Partners, a business founded in 2012 and which was borne out of work that its founder had done for Silicon Valley tech mogul Paul Allen, co-founder of Microsoft with Bill Gates. Gagik Apkarian had been a general partner at Vulcan Capital, Allen’s investment office. Allen lured Apkarian from London to Seattle and tasked him to restructure a diverse, $10 billion-plus portfolio of direct investments that needed urgent work as well as to opportunistically put fresh capital to work in new situations.
And Apkarian’s experience in managing direct investments for Allen played a part in why, about five years ago, he decided to form his own firm advising the super-rich and institutions on both how to manage existing investments better and seek new opportunities.
“There is big momentum behind the shift towards direct investing - particularly after the global financial crisis when many of the household names in private equity and hedge funds, as well as some of the most revered university endowments, lost enormous amounts of money. Investors now want more transparency, want more control and better alignment of incentives,” Apkarian told this publication in a call.
“Everyone wants to know how to do it…how to structure it and how to source deals; doing it right is extremely rewarding,” he said.
There is a lot of “hype” around direct investing at the moment, he said - understandably so - but investors need to be on guard about whether they are getting good value, appreciate the risks, and understand the amount of work such an approach requires, Apkarian continued.
When economic conditions are favorable, direct investing can seem a relatively easy and appealing route but the real test that an investor has robust processes in place and strong judgement is when markets or an investment turns sour, he said.
On that note, the other area that Tetrad focuses on is working with large family offices and international institutions in situations when their direct investments don't go according to plan. The reasons can be externally driven, such as slow economic growth or spike in costs, or internally due to overleveraged balance sheets, management disputes, shifts in competitive landscape or even fraud. As Apkarian said in the interview, “there are many advisors who are great in their vertical discipline, be it law or accounting or finance, but there are certain situations that require an integrated perspective that spans all these issues, so trying to solve it from the vantage point afforded by a career in one discipline will simply not work. Over and above this it is critical to have the view of an investor not an advisor – all the analysis and discussion distills to capital appreciation and risk mitigation”.
Large family offices work with Tetrad, he said, because of the quality and pedigree of the firm, its incessant commitment to discretion and unrelenting focus on probity – culminating in seasoned judgement that he said is well reasoned and trustworthy. “Global institutions like working with Tetrad because of its sophistication, unique multi-disciplinary skills and bespoke approach, which allows the firm to provide advice unlike any other in the market,” he said.
There is certainly plenty of coverage around direct investing. Large private equity shops such as Blackstone, Bain Capital and Carlyle, for example, allow wealthy families to co-invest on deals. At the Family Wealth Report investment summit held last September in New York, a panel discussion around direct investing touched on sectors as diverse as men’s tailoring to anti-missile defense. According to US-based Family Office Exchange, nearly 70 per cent of family offices engage in direct investing of some kind. There is another angle: the rise of private markets, with sectors such as private credit, for example, gaining traction as a result of dislocations to the world’s bank lending market since 2008.
Far and wide
Tetrad Capital Partners casts a wide net for deals, which is as it should be because the sort of opportunities Apkarian’s clients want don’t arise frequently. The team at Tetrad are all highly experienced, he said, and incentivized to put their judgement at the service of clients, and their own capital in every investment. On the investment advisory side, Tetrad charges a retainer and success fee for its work - the firm is very focused on aligning its incentives with that of its clients, it makes the majority of its remuneration when there is a successful outcome. On direct investing it levies an annual management fee and a performance slice. For every investment, a special purpose vehicle is created and the investors sit on its board, so as to create a strong alignment of interests and to give them ongoing visibility, he said.
Apkarian gives examples of work his firm has done or is doing. “We worked with a US-based private investment office to initially pursue direct investments in Canadian oil and gas opportunities. However, about a month into that effort the family’s Brazilian company defaulted on its loan. Over the next five months we helped to refinance the debt, brought in new capital and ultimately the family kept 100 per cent of the equity with a profoundly cheaper cost of financing and more flexible capital structure. As part of this work we also advised them how to reconfigure their investment team and processes.”
“We have worked for 2.5 years,” he continued, “with an international lending syndicate which lent C$3 billion to a company. The company defaulted and the lenders needed a sophisticated, multi-disciplinary firm to advise them to carry out a series of wide ranging changes including asset sales, cost reduction, management and governance changes, etc.”
He added: “We are working with a management team to do a management buyout of a listed company in Europe. Fantastic business with valuable assets. So far, we have spent over a year doing due diligence and structuring the deal and a ready to launch shortly for an investment that is going to truly outstanding.”
The work that Apkarian and his colleagues did for the likes of Paul Allen has stood them in good stead, it seems. For in certain respects the task of restructuring a set of investments held by a renowned entrepreneur sounds rather like a classic project management role - albeit one that requires not just unusually wide breadth of skills, enormous experience, numerous relationships and much tenacity but integrity and probity. In some ways, this is an accurate description of what top-notch private client wealth management really means.
In the wealth management sector as in many other walks of life there is an endless quest for the "next big thing". And in a world of ultra-low interest rates where the hunt for yield is all-consuming, a trend that is gaining ground right now is direct investment.