Friday Letter: Concentrated focus

Castik Capital’s first fundraising that closed this week ticked many boxes in term of current trends. The Luxembourg-based firm’s European Private Investment Club I is a hefty vehicle at €1 billion; it is managed by a team of former colleagues from an established firm who have set up their own fund, in this case Apax Partners; and at ten years, it fits into the expanding group of longer duration funds. It is also offering significant co-investment potential.

But it is EPIC’s limited number of investors — just six —that is most striking.

The pedigree of Castik’s investment team, led by Michael Phillips, Marc-Oliver Jauch and Michael Gröbe, undoubtedly reassured its limited partners, which are all large institutional investors from North America, Europe and Asia, that the fund was a safe harbour for a chunky commitment. Phillips told PEI that its commitments were close in size and “nicely balanced”. Big, in any case.

EPIC I’s success highlights a polarisation in the market between general partners seeking a concentrated number of LPs and those wanting to diversify their investor base to capture new sources of funds.

It also reverses the conventional wisdom that a first time fund would go out to a broad swathe of potential investors and start off with a heavy fund of funds component.

The benefits to a GP of concentrating fund commitments are clear. A smaller number of focused LPs backing your strategy and willing to plug in extra funds through co-investments smooths the investment process. For LPs, the promise of a rich seam of co-investment opportunities offers them a break on fees and carried interest payments.

Investor relations is also less of a headache. It is easier to communicate with a handful of LPs, in more detail and on a more regular basis, which in turn satisfies LPs’ growing demands for portfolio information.

And in a competitive fund raising market, LP appetite for sizeable club-style vehicles is there. Professional institutional pools of capital are getting larger thanks to record distributions, while the same funds seek to pay fees to fewer investment managers.

For a blue blood LP, investing alongside other sophisticated funds that think the same way and share interests cuts out interference by reducing the scope for conflict should any change with the fund structure require LP consultation.

But the key risks to such an arrangement are obvious. Drawing commitments from a handful of LPs leaves the GP exposed to any significant event that affects even one of its investors, and more so if the LPs themselves have highly correlated characteristics. For the LP committing huge sums to a blind pool in which they have no say over investment decisions, there is still no guarantee they will make the returns their PE portfolios and their beneficiaries require.

Whether a fund seeks to concentrate its investor base or diversify, first time fund managers, of which there are increasing numbers as experienced professionals set up their own vehicles or spin out – including Beyond Capital Partners, GENUI Partners and Mayfair Equity Partners — are having to be more creative.

In lieu of a track record, some are specialising, while others are more willing to negotiate on terms and fees. In short, they are tailoring their offering to whatever promises the fastest route to market.

And for any GP fundraising, listening to a smaller group of investors and catering to their specific requirements represents a much easier task than seeking to meet the competing needs of a diverse investor set.

“It’s a focused portfolio,” Phillips told PEI. “We spoke to investors and they like upper mid-market, long term holds and they liked the idea of having a more direct partnership with the GP.”

So that is what EPIC I does.

Reaching a close is no easy task for first time funds. We would expect many of those that do it successfully going forward to do so by answering to LPs’ particular investment criteria. We should see if we’re right in the not too distant future.