Continuing its series of Q&As relating to investment manager deals, IM Deals received the following feedback from George Bumeder, Senior Vice President of XL Group Investments LLC, which is an internal investment subsidiary of XL Group plc. Through its subsidiaries, XL Group plc is a global insurance and reinsurance company providing property, casualty and specialty products to industrial, commercial and professional firms, insurance companies and other enterprises throughout the world.
XL Group has been making minority stake investments in boutique asset management firms since the 1990’s. Prominent firms in which XL has had an ownership interest over the years include Highfields Capital, MKP Capital Management, FrontPoint Partners, Stanfield Capital Partners, HighVista Strategies, Finisterre Capital, and Polar Capital. George has been with the firm for over ten years and previously held various positions in asset management, financial services technology, and management consulting. He holds a BSE in Mechanical and Aerospace Engineering from Princeton University and an MBA from the University of Chicago Booth School of Business.
IM Deals: What are the key characteristics of a typical XL investment manager deal?
GB: XL has done a wide variety of transaction types over the past 15 or so years, but the key characteristics of our transactions are that they are (i) minority stakes, (ii) almost always equity interests (as opposed to revenue shares), and (iii) set up to be enduring, without any pre-set puts and call. We think of these as long term strategic relationships, not ‘trades’.
IM Deals: What are some of the key features you look for in analyzing investment managers in whom you are considering making a strategic investment?
GB: We look for three things principally. We look for highly talented investment managers – people who will perform for their investors but also who have an overall perspective on the markets that we can occasionally leverage in our general discussions about the entire XL investment portfolio or even our broader business. We look for good business builders. And we look for people that we want to be in business with. By this last point, I mean people with high integrity who take the concept of a strategic relationship seriously. Transaction documents will never anticipate everything that could happen, and we want to know that we are in business with people who will do the right thing, whatever the circumstances.
IM Deals: From an investor’s perspective, what are the relative advantages and disadvantages in a traditional seed deal versus an acceleration deal? For example, making a large investment in a manager who manages a couple hundred million dollars, but whose fundraising has plateaued.
GB: Investors certainly can do well with both models. The ‘seed deal’ model is clearly more of an early stage venture model, where you need to accept the fact that you will have a large number of failures, so you look for your successes to be big enough to overcome the failures. I expect that people who specialize in the seeding area need to be quick to cut their losses and move on if an investment isn’t working out. As a large institution which does only a few deals a year, we feel the ‘acceleration deal’ model is superior for us. Although we’ve had some failures, we just wouldn’t want to be investing with the mindset that a large percentage of deals aren’t going to work out. Thus, we don’t really look at the typical seeding opportunity of backing a talented portfolio manager looking to leave his or her current shop and establish a new firm. We have been involved in some seed investments, such as FrontPoint, but they tend to have unique features that help us overcome the challenges of start-up ventures. Thus, although there is a high bar for us, we would certainly do a seed deal if we found the opportunity very compelling.
IM Deals: What advantages does XL offer to its strategic asset manager relationships that distinguish it from other strategic investors?
GB: There are a number of things about XL which differentiate us as a strategic investor. First, I’d say our investment time frame. We are not investing out of a limited life vehicle; we are investing our own firm’s capital, and as we are a public company, we are happy to hold these investments indefinitely. Second, we are active LP investors in many other funds, in addition to our GP investments. Thus, we see quite a bit of what is going on in the industry, and can provide industry insight and the perspective of an experienced fund allocator when appropriate. This also means that it is quite natural for us to continue to invest with an affiliate beyond the expiration of any formal commitment, and even to invest in new products that might not have been contemplated at the time of the deal with XL. We have a very good track record of doing things like that for our affiliates. Finally, I’d say we are distinguished by our track record. XL has been doing deals for a very long time and has demonstrated to the marketplace that we are very careful selectors of the businesses we are willing to back.
IM Deals: How do you think about risk when analyzing a potential transaction? Do you place more weight on the risks inherent in the fund strategy or of the success of the investment manager (which are of course related, but can be separated into two distinct investment decisions)? How do you think about the tension between preserving fund capital in a lower risk fund strategy (with accordingly lower returns), and a higher risk fund strategy whose returns, if successful, are more likely to attract institutional capital?
GB: In almost all of our deals, we will be significant investors in the fund product(s) in addition to the management company, and there is generally the potential for far greater financial loss through poor risk management at the fund level than there is in failure at the management company level. We look for people and strategies that have a high probability of mitigating losses in stress markets. We also know, however, that people won’t invest in alternatives unless there is some level of reward for the lower levels of transparency and liquidity, as compared to, say, investing in liquid public securities. We are looking for businesses that strike an appropriate balance between risk and return, but the expectation of meaningful outperformance needs to be there. There also needs to be a high level of business management skills among the founders. This can take the form of a portfolio manager with the right skill set, or someone who has built a team that includes strong people in the operations, compliance, and business management functions.
IM Deals: In your view, are manager stake investment strategies poised to grow, decline, or stay flat over the next few years? In particular, do you think recent challenges in raising investment funds for seed-focused investment strategies represent a decline in the interest in seed investment strategies generally, or is it reflective of the general challenges in raising capital for fund-of-fund strategies?
GB: Investing in management companies is more of a private equity business than a fund-of-funds business, and requires capital of that type of tenor. It has been a very difficult market for raising capital for many alternative strategies, in particular illiquid strategies, and that certainly seems to have had an effect on fundraising for vehicles that take manager stakes. That being said, some large pools of capital have been raised in the space, and the opportunity set for investing in managers is quite strong. The effects of Dodd Frank, the generational changes happening at larger managers, and the effects of the financial crisis have all combined to produce an environment where there are many early- or mid- stage managers out there looking to grow, yet the barriers to that growth they are seeking in terms of current size and infrastructure needs are higher than ever. There is also a greater appreciation for the benefits of having an institutional shareholder as part of the cap table if you are a manager. For these reasons and others, we think the environment is very promising for the types of transactions on which we are focusing.