Q&A - John Gripton, Managing director, Capital Dynamics

Given the downturn in the markets, do you as an LP do anything differently now? What advice would you give to a first time investor?

We would not do a lot differently now, as I believe private equity is a long-term asset class where you can't opt in or out of various sectors based on where the market is. Capital Dynamics keeps a broad, diversified portfolio and while there may be some more exposure to distressed assets now, we would not make a drastic shift in strategy. We always look at the best managers for each area of private equity and their returns over an average of 10 years or so, not on a year-by-year basis. For a first-time investor, I would say that now more than ever, they need the support of specialist managers or advisers in the market. In the current economic environment it is a whole different ball game now and a lot more work is required in identifying which managers to support. With performance in recent years it's not going to be as easy as it was before, as now investors will have to think more about portfolio and risk management strategies. They must carefully consider how much they want to commit now and if they will be able to sustain this amount going forward.

What would you say is the biggest change in terms of how a GP treats its LPs now?

I would say that with better GPs, those that are looking to make long-term relationships with LPs, very little has actually changed. Those that were more opportunistic in the past will not be able to command the terms they did previously. Things that will change are not necessarily the management fees or carried interest, but rather there will be more of a focus on areas such as key-man clause and transaction fee issues. LPs have been frustrated to a degree in the past with key-man clauses that have been too weak and with the lack of transparency on transaction fees. Investors will also be able to press more for the information that is necessary for them to do their jobs.

What is more relevant when assessing the merit of a GP, their track record or the current underlying portfolio?

Both are incredibly important, but for different reasons. The track record looks at managers' ability to generate returns through different economic cycles. You can't rely on this to predict future performance, but it does give a measure of the GP's experience over differing cycles. If a manager has one buyout fund that didn't make the best returns, this is no reason not to invest with them. Current underlying portfolio is now more important than ever, in the sense that you have to look at the health of each individual company. This includes the company's performance, how it is structured in terms of debt, when it will need to be refinanced, etc. Capital Dynamics has always looked at this, but we are now doing it more carefully than before and with a different emphasis. Which members of the GP's team are really involved in the current portfolio? Will these same people be there in the future? This will be particularly important when the debt of these companies matures in 2013 and a great deal of work is required.

What is the best indication of the true skill of a GP - cash in vs out over the last five years, or current performance (realised and unrealised)?

I think that cash in vs out in the last five years is important, especially when merged with managers' track records. If a GP didn't divest between 2006 and 2007, then a big question to the manager would be, why? Were they investing more than divesting? Have they overpaid for their investments? We are less likely to invest with a GP that hasn't maintained pricing discipline consistently. But there is never a time where our due diligence doesn't give rise to some concern. The question is whether the concern is sufficient to stop us from investing. We must be able to address the issue or get comfortable with it. With current performance, we would again look at the health of the underlying companies. Are the companies profitable and performing to plan - to the original budget as well as this year's? If there are problems here, then we would have to question and reassess the value of unrealised performance. However, if companies are valued at zero, this is not to say that they will not be of value in two to three years time. The unrealised part of a GP's performance is also crucial in terms of workload and understanding how well the manager will be able to cope with it in the future.

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