Five questions with Flexstone’s Eric Deram

Flexstone Partners held the final close on its latest secondaries and co-investment fund in mid-July on more than twice the amount raised for its debut.

The Geneva-headquartered firm, which was formed in December from the merger of three of Natixis Investment Managers’ fund of funds units, collected €300 million for Select Opportunities II. Managing partner Eric Deram speaks to Secondaries Investor.

Can you talk us through the rationale behind the size increase?

The rationale behind doubling the size is supported by the level of dealflow generated by Flexstone, which justifies a larger pool of capital to be deployed over an investment period of up to four years. Moreover, most of the secondaries and co-investments closed by Flexstone have a larger capacity than the ticket size defined for Select Opportunities I.

In terms of portfolio construction, Select Opportunities II will be made up of up to 25 investments with an average ticket size of between €10 million and €15 million each. This amounts to one or two additional deals per year compared with Select Opportunities I and a ticket size increase of €2.5 million to €5 million.

How did you find the fundraising process? What were the questions that kept coming up from investors?

Over the 18-month process we found the response to our strategy, combining secondary and co-investments in one integrated portfolio, resonated well with investors. We spent time explaining that this is an effective way to build a portfolio of diversified investments in European small- and mid-cap private companies, as demonstrated by the top-quartile performance of our first fund.

The question of underlying fees remains the most common issue raised by investors. However, the moderate pricing of the fund, coupled with the limited-to-no-cost basis of the underlying assets, make the fund an efficient investment vehicle in terms of total expense ratio, diversification, velocity, and risk and return profile. For most of our clients, Select Opportunities II is accessible with a 1 percent management fee and 12.5 percent carried interest above 8 percent.

What were you looking for in the new investors you brought into the fund?

Our main objective was to enlarge and diversify our investor base compared with Fund I, both in terms of type and region. There are around twenty institutional investors – insurers, pension funds and banks – as well as private professional investors and family offices, which account for around 7 percent. We were also pleased to have won the confidence of new investors from Asia, which account for approximately 10 percent of the fund. New investors represent 60 percent of the fund and 100 percent of Fund I investors reallocated to the new fund.

What type of secondaries investments look particularly attractive to you at the moment?

It is our intention to remain at the low end of the secondaries market. Here is where we see plenty of market opportunities, in a less efficient segment of the market with less sophisticated sellers, less intermediated transactions and a deeper pool of funds. Europe is a very mature and complex market with plenty of country-focused funds and sector-specific funds, which are often less known to many investors.

We will concentrate on smaller transactions, with a clear focus on single lines and small sub-portfolios where Flexstone has a strong primary angle. We might also consider opportunities in the GP-led segment as long as we remain comfortable with the quality of the underlying managers.

How is the point in the cycle affecting your investment approach?

We are focusing on late-stage secondaries managed by leading managers. This enables us to have a better visibility on these portfolios and price them more accurately. The higher velocity of cashflows also creates a sort of downside protection with most of the invested cost repaid quickly, should the environment deteriorate. The first two secondaries investments in Select Opportunities II are tail-end portfolios of 2007 vintage, good examples of our emphasis on mature secondaries transactions.

Our investment strategy focuses on two pillars: first, value creation should primarily be the result of growth and operational improvements at portfolio company level; second, portfolios should be concentrated, with capital allocated only to a limited number of top performing fund managers yet diversified across vintages, fund types and geographies.

Although Select Opportunities I was deployed in a flourishing economic context, more than 55 percent of the performance has been generated through the growth and operational improvements at portfolio company level.