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Private Equity in the spotlight

Date: 30 March 2022

In today’s Fund Buyer we catch up on private equity, an asset class that has clearly had a very successful few years but may be more challenged now. Much has been made of the recent shift from growth to value, as markets grapple with the prospects of prolonged elevated inflation and rising interest rates.

This has resulted in the higher growth parts of the market struggling year-to-date and is having knock on effects in the private equity space.

Private equity has done very well in recent years as more and more companies chose to stay private for longer. This has allowed private equity managers the opportunity to capture large gains in an environment where there was a thirst for growth companies.

Now, however, private equity faces a complicated time as investors switch to a risk off position due to a more uncertain environment and listed growth stocks have been significantly de-rated. Nevertheless, despite market difficulties, in my view private equity remains a long-term theme that investors should be looking to own as part of their broader portfolio.

Given the liquidity concerns of investing in early-stage and illiquid companies, investment trusts have been the traditional vehicle of choice for investors. With shares in the trusts traded on the main market, this helps remove the liquidity issue that has made other illiquid areas of the market, such as property funds, unpopular in open ended format. That said, investing or exiting in size still depends on the liquidity of the vehicle itself.

The majority of the UK listed direct and Fund of Fund PE trusts are well ahead of the market return in fact.

If we take a look at the 5-year price returns to Friday’s close, performance has been excellent. HG Capital leads the way, with a return of 214% compared to 64% for MSCI AC World. The majority of the UK listed direct and Fund of Fund PE trusts are well ahead of the market return in fact. Shorter term is also very illuminating and over the last 6 months the market is up 1%.  During this period private equity trusts have a clear split as newer growth capital trusts, most of which are most recent launches, have really struggled in share price terms, with Chrysalis Investments seeing the biggest short-term fall, down 34%. However, once more the direct and fund of fund trusts have held up relatively well over that period, with a handful up double digits. YTD has certainly been a rockier road for the vast majority, with the market rightly presuming that underlying valuations will likely be marked down in time in line with market declines.

Moving back to the bigger picture, the private equity investment trust space is one that continues to see a lot of innovation. A good number of trusts in traditional asset class areas have added to their ability to buy unlisted investments. Baille Gifford via Scottish Mortgage led the way for equity trusts on this front, followed by a number of other houses such as Fidelity and Blackrock, for whom UK equity vehicle Blackrock Throgmorton recently received authorisation to invest a small amount in unquoteds, whilst Fidelity Japan Trust is looking to increase its ability to allocate at its May AGM. There are also the likes of RIT Capital and Caledonia which would be considered as hybrid investment trusts with significant private equity exposure alongside traditional equity and other asset classes in the case of RIT.

With more companies wanting to remain private for longer, professional investors are waking up to the opportunities these names can provide. Some trusts will now hold a private company well beyond listing, highlighting how private equity can be fertile hunting ground for the winners of tomorrow.

There are clearly risks that investors should be wary of. Premiums and discounts may be inconsistent in the sector and many of the new launches tend to be focused on growth companies and until recently were generally on big premiums, indeed Schiehallion, the Baillie Gifford vehicle, remains on one. Discounts can also blow out rapidly and given recent volatility we could see private equity trusts suffer when quarterly valuations are struck. At this stage, there is understandable nervousness about how valuations will be affected by the de-rating of quoted growth companies. Interestingly, the one area that has been pretty stable has been the fund of Funds group of trusts, who have remained stubbornly in and around mid-20s discounts, but this represents where they have been longer term.

Another longer-term concern for many investors is cost.

Another longer-term concern for many investors is cost, and this continues to garner headlines. It’s fair to say that despite the very good long-term performance we mentioned earlier, the aggregate cost reported by these trusts looks very high versus a plain vanilla equity or bond fund. This might be acceptable when a trust is performing well in excess of the market, but in leaner years those costs begin to look steep, so investors need to ensure they understand that they are buying for the long-term. The recent performance fees paid to the managers of the Chrysalis investments trust was another good example of these costs getting more scrutiny. 

That all said, private equity remains an innovative sector offering differentiated opportunities, in my view. With discounts present there are opportunities for investors, but it will be a volatile ride in the short-term. I think all investors with a long enough time horizon should consider it as part of their investment mix, whether that’s the higher growth capital trusts that have struggled of late or the much more broadly diversified global fund of funds.

This is a marketing communication and is not independent investment research. Financial Instruments referred to are not subject to a prohibition on dealing ahead of the dissemination of this marketing communication. Any reference to any securities or instruments is not a personal recommendation and it should not be regarded as a solicitation or an offer to buy or sell any securities or instruments mentioned in it.

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