Expands on Alpha Bets presentation on how the consistently high performers do it.

1. DELIVERING CONSISTENTLY HIGH PRIVATE EQUITY PERFORMANCE
Logan M. Cheek, III
Note: This text introduced an article appearing in PREQIN’s 2011 Global Review of Private Equity
<http://www.preqin.com/docs/samples/2011_Preqin_Private_Equity_Report_Sample_Pages.pdf?rnd=1>listing those fund
managers in various categories (buyout, real estate, natural resources, infrastructure, fund of funds, and venture capital) who
were “consistently high performers” among managers who have raised at least three funds, one of which has been in the last
six years.
How do top performers deliver consistently for their investors? PREQIN's recent rankings have triggered questions from many
asset managers, as well as their investor LPs as to "How do you do it?" The PREQIN analysis clearly suggests that at least
among the top performers in this business, their life is one of serial persistence, not random walk.
To follow up on this question of “how”, we made a series of telephone calls to some of the high performers from PREQIN's
most recent rankings of buyout, venture, FoF, and special situation categories. To be sure, the survey was unscientific, in that it
didn’t incorporate responses from all of those so ranked – some declined to comment, others were in a fundraising mode. But
in many cases, we were able to glean comments from their recent press, or their internet sites. While there were differences in
some of their responses, here are a dozen of the most frequent and consistent responses:
¶ Top performers don't chase or react to opportunities, they proactively initiate them. You can waste a lot of time
reacting to over-the-transom deal flow, or reviewing suggestions from a well-cultivated stable of brokers, accountants,
investment bankers, and lawyers, or attending investment forums. One PE manager even called the investment
forums, "gong shows".
(This proactive approach to creating investor value is one Vinod Khosla championed at Kleiner.)
Nexxus Capital’s Roberto Terrazas notes “We prefer to select industries, create consolidating platforms and then
approach the companies that will help us to reach that objective.” Charlie Huebner of RCP Advisors, a Chicago-based
mid-market buyout fund of funds manager suggests “Make sure your business / investment model is giving your
investors real value ... something that they can't easily get somewhere else or through their own efforts. While this
seems obvious, it is often ignored. Firms can exist in denial of this for a period of time, but not in the long term.”
¶ Top performers define what they're going to do in terms of problems to be solved -- what Eddie Murphy once called
the "BFD" (For family audiences this means "Big Fantastic Deal.") Then they bring to that problem a big solution
with a big league management team, putting it all together on favorable terms. Again, Charlie Huebner suggests,
“Always challenge yourself that your ideas and services solve real problems.”
¶ Top performers have a rigorous and in many cases proprietary process to assess their deals, and particularly their
management teams. Some have "proven entrepreneurial benches" (or real estate, or infrastructure, or turnaround
experts) they work with; others, (like us) couple those with very sophisticated and validated ways of assessing
entrepreneurial talent through our biographic screening profile. Again, Huebner agrees, “Rely on a disciplined
analytical process to understand opportunities and risks.”

2. ¶ Top performers specialize. As one institutional manager stated "I'd rather invest in a specialist, rather than a
generalist. On his worst day, my specialist will outperform your generalist." Or as Tom Peters says "Stick to your
knitting." Charlie Huebner is even more succinct: “Specialize”.
¶ Top performers get involved in their companies on a hands-on, not portfolio basis. Portfolio management is OK for
hedge fund managers and other asset managers who can manage billions of publicly traded securities from a CRT
screen, assisted by sophisticated computer algorithms. But in the private equity arena, you have to get involved in
your investments. Again, Terrazas comments, “We have a ratio of about 3:1 investment professionals per portfolio
company.” Peters calls this "MBWA" ("Management by walking around").
¶ In order to do all this well, you can't take on too much investment capital. At least in the venture capital space, assets
under management cannot exceed $75 million per full time equivalent general partner. More money under
management per partner lowers returns. Less money is uneconomic. This has been confirmed by some recent
academic studies. As Huebner advises, “Excessive … capital is the enemy of excellent investment returns.”
¶ Top performers pick their sectors carefully, rigorously and early. For any area of the world, there are a handful of
areas that will experience explosive demand in the next decade. They will differ for different countries, and even
within sectors and subsectors of those countries.1
¶ Top performers don't try to invent, or even reinvent the wheel. There's an old saw out there that "pioneers get arrows
in their backs." With problems and opportunities throughout the world, there are often proven solutions to them
somewhere. If the solution has been devised somewhere else in the world, seek it out and use it. Even if you can't use
it, you can learn from it, and apply the lessons learned.2 This eliminates the risk of the initial "test drive" of the
unproven, with attendant technical, product, marketing and ramp-up risks. As Yogi Berra says, "You can see a lot by
looking around."
¶ When working outside your home market or country, the top performers manage their cultural, political, currency,
corruption, and inflation risks proactively. These risks are (or were) generally unknown when working only in a US or
European environment in earlier years. Then along came a lot of opportunities elsewhere, especially in the emergings.
And, in the US, there was Enron, Madoff, and others. Simply "redoubling the diligence of the investment managers"
to mitigate the risks posed by the Ken Lays and Jeff Skillings of the world is not enough.
- Critical to success in whatever country you're operating in is having a resident, native partners present in
each country. Top performers don't have time to OJT otherwise very bright and talented US MBAs in the
subtleties of operating abroad in Asian and Latin cultures, or vice versa in the US. Several "household name"
1
Looking to assess the "big picture" opportunities of the next 15 years? Check out the DNI / CIA's recent unclassified Global
Trends 2025 <http://www.dni.gov/nic/PDF_2025/2025_Global_Trends_Final_Report.pdf>
2
We've found that successful fund managers and our operating managers and entrepreneurs spend one to two hours per week
absorbing the professional literature in their field. If less, they lose valuable insights of what's happening around them. If more,
they succumb to "paralysis through analysis" in their decision making.

3. IBs, VCs, and PE fund managers have made that mistake when they first entered the Asian markets. And
everyone recalls the Japanese institutions getting burned in Rockefeller Center, Hollywood, and Toyota's first
try at the American market. While un-PC to many in the PC world of the twenty first century, Rudyard
Kipling's "White Man's Burden" and lines from "The Naulahka"3 apply equally to all, whether you're an
Asian operating in Europe, an American operating in India, or any investor anywhere in the world
considering an initiative outside your expertise and native culture.
- Top performers employ systematic approaches to mitigating risk, other than calling in their insurance
broker. We employ the services of some very high paid (but part time) outsiders on our unique "Policy and
Intelligence Committee". P&I can veto all deals proposed by the Investment Committee, and advise on an
ongoing basis on appropriate hedges for the local risks posed by the emergings. This allows us, the partners
responsible for the investments, to focus on making returns, while P&I covers our flanks on the macro-risks.
Other top performers leverage the skills of their outside advisors, on a less formal, but no less rigorous basis.
¶ Top performers don't get involved in any deal involving human rights problems, exploiting child labor, women,
low-wages, caste or class differences, or environmental risks. Top performers don't like getting their offices picketed,
or being subpoenaed, any more than their investing limited partners. Life's too short to be folding fitted sheets, when
so many better opportunities are available.
We do get involved in deals that in addition to promising exceptional IRR, enjoy massive grass roots and top level
political support. An electric car that runs for 500 miles and recharges in five minutes, or an ethanol technology not
requiring public subsidies qualifies, as does almost any cost-reducing clean tech or sustainable technology. We leave
the cures and palliatives for things like toe nail fungus, or niche opportunities to others.
In our pro bono work, we focus on involving in such things as entrepreneurship education in local universities, or, for
our offices outside the US (especially in China and India) instruction in business English. Others write well informed
"how to" blogs. Many LPs feel this is a distraction to their GPs being totally involved and dedicated to the portfolio;
most top performers find that the long term goodwill pays back many times over. In addition to goodwill, it’s also a
great way to "see a lot by looking around."
¶ Top performers pay attention to LP relations. One Danish public pension fund recently commented to PREQIN,
"The market is not very transparent. Reports from GPs are quarterly so there are lags from fund events. ... GPs are not
very forthcoming with additional information requests.” Again, Charlie Huebner of RCP Advisers comments,
“Maintain a transparent, candid, and consultative communications relationship with your investors.”
More and more top performers now have an in-house investor relations capability. On the other hand, for the general
public, private equity is still private equity." Top performers emulate Henry Hillman's most frequent quote, "Whales
only get harpooned when they come up to spout" while not going to the extreme of Howard Hughes’ latter days.
3
"And at the end of the fight is a tombstone white, and an epitaph drear' 'Here lies a fool who tried to hustle the East.'"

4. ¶ Top performers have integrated teams that are locked together in a shared partnership culture and confirmed by
"golden handcuff" management agreements. Even though all the top-ranked PREQIN funds have been around for a
while, the teams that staff their current partnerships in many cases have not. This suggests worrying about "first time
funds" is less important than assessing whether the team you’re going to back is tuned into a common culture and
processes that make sense.
A lot of this sounds like "motherhood." The top performers call it "best practices" or "back to the basics." In either case, it led
to superior investment performance industry-wide up to about 2000. All top performers have consistently and persistently
continued to deliver by employing them since then. Had others followed these principles in the last decade, the industry’s
marginal returns would have been different.
Accordingly, we'd suggest all the above points as a "checklist" for LPs considering any investment offering. Rather than
focusing on "top quartile ranking", remember that "top quartile" performance was not an outgrowth superior past performance,
but the result of following proven internal processes like the above that caused those results -- consistently, and over time.
Again, as Huebner notes, “While good high performance is usually persistent, don't rely on this too much. Understand the root
causes for that performance. If you can't clearly figure this out, you may be dealing with either good luck or a ‘high tide lifts all
ships’ phenomenon.” As Phil Horsley of Horsley Bridge has frequently said, “It’s a game of process and people.”