Commercializing Diversity

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The Private Fund Investments Group is investing more than just capital in the Emerging Domestic Market.

When the Private Fund Investments Group (PFIG) first made its way into the EDM space three years ago, the group’s knowledge of the space and its players was relatively limited. PFIG, a fund of funds, is part of the private equity business at Lehman Brothers. Initially, EDM-focused private equity funds were no more than a blip on the group’s radar screen. After getting to know the players in the market, the group saw an opportunity to put $300 to $400 million to work in the space over three to four years. PFIG went on to develop a distinct approach to EDM-focused private equity investments and, over time, EDM investments have become an important component of the group’s overall business strategy.

Since the group’s initial foray into the market, the Manhattan-based operation has invested in four EDM funds: Linx, ICV, GeNx360 and Vista Equity Partners. In addition, the group completed two co-investments with Linx and ICV, and each of the group’s six ventures in the EDM space has shown initial success. Patricia Miller Zollar, PFIG’s managing director, says EDM investments were a natural outgrowth of the group’s 20-year private equity fund of funds experience and $10 billion of assets under management. The EDM primary investments and co-investments represent a combined total of $65 million.

“It was an extension of our success in private equity investing and our commitment to diversity,” Miller Zollar says. “We have a passion for diversity and investing, as well as a long-documented, successful track record of choosing great managers.”

Long considered an innovator in private equity, PFIG’s client list includes corporations, governments and municipalities, institutions and high net worth individuals worldwide.

Before diving into the EDM market, PFIG questioned whether the move made sense. “Around here, we don’t just come up with an idea one day and do it the next,” Miller Zollar says. At the time the company began seriously exploring the EDM, Miller Zollar was with Partnership Solutions, a business focused on commercializing diversity. She remembers that the department was particularly excited with the potential opportunities in Private Equity — an arena where she says the company was encountering some “of the most talented” women and minority investors.

“We had a number of internal discussions to determine if this was the right move for us, all in the name of recognizing if there was an opportunity to invest in these private equity funds that are run by women and minorities,” Miller Zollar says, adding that the company weighed two additional factors. “We also considered whether we had the skills needed to source high quality managers in this area, and how we were going to differentiate ourselves.”

The team took its time working through these considerations and Miller Zollar recalls that it wasn’t enough to have one or two of them covered. “We had to have all three,” she says. That’s because the company has historically based its business model on doing something different, she adds, and not simply following the crowd. “We wanted to make sure that our skill sets and network linked us to identifying the best managers in the EDM space.” They also wanted to be sure they were successfully accessing this vibrant market. Eventually, after much analysis, Miller Zollar says all three pieces of the puzzle fell into place, and the group began working with a few EDM-focused funds.

“Each one had special attributes,” Miller Zollar says. “For each investment, the managers came to speak about their business propositions in a manner that showed us how they set themselves apart from everyone else. The managers who impressed us most went beyond what business schools they went to, or what banks they worked at, or how they were going to find companies, buy them, run them and turn them around in a few years.”

In fact, their stories ran far deeper than the typical, superficial elevator pitch that many private equity investment groups are accustomed to telling. “They really understood the key areas in which they could add value, whether it was the ability to run a company [from an operational standpoint], structure a deal or construct a portfolio,” Miller Zollar says.

It was also important that the group was differentiated from the funds in which it invested. For example, earlier this year PFIG helped on an EDM deal with an entity considering investment in a large transaction with significant commodity exposure. To successfully complete the transaction, the EDM fund needed help determining the commodity risk and whether or not that risk could be hedged. “We structured and priced a hedge for them,” Miller Zollar says.

In another example, PFIG worked with GeNx360 to research potential investments in the oil and gas industry. “We linked them with our research team to help them analyze certain industry risk,” Miller Zollar says.

PFIG has also served as a navigational beacon for EDM entities in need of guidance with their startup and operations. For example, PFIG assisted one venture fund with its LLC setup and negotiations and will sit on the fund’s board of directors in order to provide expertise and perspective.

It’s a role that not all institutional investors are willing to play, but one that PFIG gladly takes on when the recipient’s odds of succeeding are high. “Quite honestly, most investors couldn’t take the time to do all of this in helping to institutionalize a fund.”

Standing Apart

PFIG prides itself on the ability to rise above the crowd and offer financial solutions that its competitors can’t match. The same philosophy has carried over to the group’s foray into the EDM space, according to Brien Smith, managing director and senior member of PFIG . For starters, he says the company forms true partnerships with the EDM funds that it invests in, thus helping nascent and budding entities reach their full potential in fewer steps.

“The same team that reviews and provides oversight for our core business is also working directly with the EDM funds, and communicating preeminent ‘manager and investor’ reporting practices,” Smith says. “We’re big believers in investor communications, with respect to either good news or bad news.”

Sergio Sotolongo, chairman and CEO of the Student Funding Group LLC (StuFund), based in Liberty Corner, N.J., has been working with PFIG since 2006, and says the relationship included not only a first round of financing, but also extensive partnering, education and networking opportunities provided by the larger entity.

“Part of our business model includes going to corporations and selling our services as a bundle of employee benefits,” Sotolongo explains. “Not only did PFIG introduce us to various folks within its own internal organization to help achieve that, but it was also helpful in positioning us with other companies they do business with.”

StuFund also takes part in weekly phone calls with individuals from PFIG’s sister group, the Partnership Solutions Group, which reviews marketing, college marketing and other opportunities. “That gave us a pretty nice view with some of our college and university clients and resulted in a very deep, strong relationship,” Sotolongo says.

Going the Extra Mile

As an investor, PFIG also aids in compliance, particularly in the fair value accounting and FASB157 arena, which deals with portfolio valuations. And, while younger companies with just a few funds and investments may have limited access to resources necessary for developing parameters to comply with such laws, Smith says PFIG provides significant support in this area. The same goes for due diligence — an area that the company has been honing and improving since the 1980s.

Miller Zollar says PFIG also stands out by looking not only at specific investment opportunities, but also considering other occasions to get involved with certain funds. In evaluating a private equity fund investment, for example, the company will look at other types of investments (such as co-investments, two of which it is currently considering) that would create a catalyst for more investment within the EDM space. Taking an interest in the general partner management company is another option, says Miller Zollar, whose team will identify managers that may not yet be “up and running” as a firm and could benefit from a partnership with PFIG.

“From a minority or woman-owned standpoint, the benefits come in the fact that [PFIG] is backing them in a time when capital is limited for new businesses,” Miller Zollar says. She adds that the company has yet to make any general partner commitments, but is constantly looking for the right relationship.

When investing in the EDM space, PFIG considers factors like capabilities, deal flow and the potential for positive returns. A 58- person due diligence team of executives situated throughout the world pores over these and other criteria to come up with the best possible opportunities, identifying the funds with the greatest potential and then uncovering distinguishing characteristics of outperformers. “Those out-performers could be first- or second-time funds, just as easily as they could be sixth-time funds,” Miller Zollar says.

Risks and Rewards

When PFIG ventured into the EDM space, the group realized that the move would come with both risks and rewards. According to Miller Zollar, one of the key challenges was getting their arms around the space — a virtually impossible task in the fragmented market. So far, the company has identified about 100 minority- and woman-owned private equity funds. “We’re constantly making sure that we know which managers are in the space, how they compete and what’s special about them,” Miller Zollar says.

“Emerging managers are sometimes lesser known because they are smaller, and are not the ones showing up on the covers of the trade magazines.”

PFIG anticipates partnering with about 10 to 12 managers. Miller Zollar says the group wants to create a large impact on just a few funds, rather than spreading its efforts among dozens of funds. That creates another challenge: having to say no to good candidates.

“When you’re selective and thinking about portfolio diversification, you have to turn down a lot of opportunities, not only in the EDM space, but across the board,” Miller Zollar says.

Internally, Miller Zollar and her team continue to work with their colleagues to counter the misperception that the EDM space is somehow about social investing. “That’s definitely the wrong way to think about it because the EDM stands on its own feet from a commercial standpoint, in terms of the returns that it delivers. If people don’t understand that, it’s going to be hard for EDM to be a long-term and sustaining investment area,” she says.

While it wrestles with these ongoing challenges, Miller Zollar says PFIG is reaping the rewards of being involved in the EDM space, where early signs of success include the introduction of new investors to the marketplace for investments in minority- and woman-owned funds. The fact that several possible general partner candidates have surfaced over the last year is also a positive sign. Miller Zollar sees those groups’ readiness to receive institutional money as a result of conversations they’ve had with the team.

“While it’s too early to report returns on our EDM investments, we are definitely having a positive impact on the marketplace.

Especially for the first-time fund managers, we’re bringing insight that they can’t get anywhere else. We see this manifest itself as they get ready to come out and become more institutionalized.”

Going Forward

As PFIG’s EDM practice continues to build its presence in the space, the company will also continue exploring new ways to create impact in the market and to serve as a true partner with the funds in which it invests. In Smith’s view, the current market is primed for such intervention.

“There are going to be a lot of professionals who are well-suited to building their own companies and practices, and we want to be there to support them,” Smith says. He has his eye on returns as PFIG’s EDM investments continue to grow.

“We hold all of our investment relationships to a high degree of standards. Success breeds success in this business, and to build a growing and sustainable group you have to be able to deliver returns.”

Going forward, Miller Zollar sees significant opportunity in first-time funds that could benefit from PFIG’s 20 years of experience in private equity. “At the same time, we’ll continue to take in more money from key clients who want access to the EDM space and who want to leverage our group to get there,” she says.

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