Is there a turnaround fund in your company's future?

• Author: von Braun, Peter
• Position: Pension funds

Is there a turnaround fund in your company's future? Chief financial officers face a dilemman. Many love the returns produced by the early LBOs, but they question whether these profits can be sustained in an environment of high-priced deals and political problems. More and more, they are considering turnaround investment vehicles as a profitable alternative. And why not? Some turnaround investments can produce returns of more than 40 percent annually compounded.

But before a CFO, along with his or her pension manager, can confidently recommend to the company that it should participate in a turnaround vehicle, the chief financial officer should be able to answer these questions:

* Why should you consider investing in turnaround vehicles?

* Where does turnaround investing fit in the overall corporate investment strategy?

* How do you evaluate turnaround managers?

* What type of turnaround fund should you choose?

* How should you work with and direct a turnaround investment manager?

When and where

turnarounds work

There are three basic reasons for considering turnaround investing. First, properly structured and executed, turnarounds can produce excellent profits, thereby making a disproportionate contribution to financing corporate pension obligations. Some turnaround managers working with public companies in trouble have produced returns of more than 100 percent annually.

A second reason is that turnaround investing parallels a CFO's experience and skills more closely than many other forms of investment and is far less subject to exogenous factors, such as the stock market. CFOs understand the basic approach and tools used by turnaround managers and can actively comment on and judge what is being done to enhance the value of the investments.

Third, turnaround investments can provide important secondary benefits as they create jobs and stimulate new investment, thereby overcoming many of the objections to LBOs.

As for fitting turnarounds into the corporate strategy, most executives realize that investment vehicles cannot be considered in isolation. They need to fit into the overall asset allocation mix among domestic and international markets, classes of securities, vehicles, risks, and return expectations. Many CFOs have set aside a certain portion of their total pension fund assets for alternative investments. The popularity of these types of investment has ebbed and flowed over the years, as the choices have ranged from real estate to oil and gas, to international investments, to LBOs. But while the relative mix has changed, the principal has become well established that alternative investments are a valuable part of the overall asset mix.

There are two basic positions for turnarounds in this overall strategy. Given the normal risk profile of most pension funds, only a small portion of a fund's assets should be committed to turnaround investing. Strategically, turnarounds are a long-term, return-enhancement vehicle and a hedge against poor performance in other asset classes. Tactically, they are an attractive vehicle for putting to work any uncommitted funds scheduled for LBOs or venture capital investments.

How to evaluate a

turnaround manager

Because profitable participation in turnarounds traditionally has been the province of a small band of professionals, turnarounds are only just emerging as an institutional vehicle. Therefore, institutional investors have little experience in evaluating the abilities of turnaround managers.

The first step in the evaluation process is to look at the basics: people and track record. There is no substitute for fund managers having...