Busting some of the common myths about investing in private equity

Helen Steers, Partner at Pantheon and Manager of Pantheon International Plc (PIP), addresses some of the common myths surrounding private equity.

Investors looking for attractive risk-adjusted returns over the long term might consider private equity, which has strong performance credentials and can offer significant diversification benefits when added to a wider portfolio of assets.

Sounds good, however capital in the private equity industry (which covers a range of stages in a company’s life from venture capital and growth equity through to buyouts, and also includes take-private transactions) is managed predominantly in illiquid non-listed structures. Very high minimum investments are often required and investors are typically expected to lock their capital in for a long time – usually 10 years at least.

Many investors do not have direct access to the best performing private equity managers – an important element of investing well in this asset class given the wide dispersion of returns between the top and bottom quartiles – or they don’t have the resources necessary to handle the complex nature and administration required to manage private equity investments.

So, private equity is difficult or even impossible to access for certain investor types then? Not necessarily. Here we will debunk this and some other myths surrounding private equity. Investors should always consider the risks and the respective advantages or disadvantages of investing in private equity and remember that, as with any investment, past performance does not indicate future results. 

Myth 1: Private equity isn’t accessible for certain types of investor

While there can be significant barriers to entry for those seeking to tap into the opportunities presented by private equity, one accessible way is to buy shares in a private equity investment trust, which is a closed-ended investment company that is listed on a stock exchange.

Those investors who seek to reduce risk, while still benefiting from the specialist research and analysis of a professional investment group, could consider a trust such as Pantheon International Plc (stock ticker code: PIN), which is one of the longest established private equity funds on the London Stock Exchange and a constituent of the FTSE 250. As reported at 31 October 2020, PIP has net assets of £1.6bn and has generated average NAV growth of 11.6% per year since it was launched over 33 years ago in 1987. Through just one share in PIP, investors can easily participate in an actively managed, globally diversified portfolio of high quality, hand-picked private assets. 

Shares in an investment trust like PIP are bought and sold in the same way as any other publicly traded share. In addition, the capital gains that arise are retained within an investment trust structure are not subject to corporation tax.[1]

Myth 2: Private equity prospers at the expense of investee companies

In the early days of private equity, managers often relied mostly upon leverage to generate investment returns. Nowadays, private equity managers use a wider set of value creation tools, where more emphasis is placed on the operational improvement of businesses, focusing on both top-line and bottom-line growth, strategic re-positioning and buy-and-build strategies. It is worth remembering that private equity managers operate within long-term (typically three to seven year) investment horizons, looking for high quality companies that are often in niche sectors and demonstrate real growth potential. They focus on creating value in the investee businesses through hands-on operational and strategic support, and their approach may also include reinforcing the management team and appointing industry experts to the company’s board. Private equity managers that are focused on buyout transactions utilise debt as well as equity to acquire a business, but are disciplined in their use of leverage, as they seek to achieve optimisation of the business’s capital structure. Venture capital and growth equity managers, who are taking minority stakes in companies, normally do not use leverage. The best private equity managers are typically sector experts who bring significant expertise, knowledge, networks and contacts to a business.  In general, private equity managers are nimble and are able to spot long-term trends, enabling them to back future “winners” that become well-known success stories. Recent examples of this in Europe are Spotify and Just Eat – both companies benefited from rounds of venture capital and growth equity, and were in PIP’s portfolio at the time that they went public. The ability of the private equity managers in PIP’s portfolio to identify long-term trends has also served them well so far in the COVID-19 pandemic. Prior to the onset of the crisis many of PIP’s managers were investing in sectors that are focused on the rapid digitalisation of the economy, process automation and data management, and others had backed segments in the healthcare and consumer services areas that were benefiting from secular trends driven by demographics and lifestyle shifts. All these sectors have shown resilience over the past several months, and have weathered the storm well. Furthermore, although our private equity managers could not have predicted the trigger for the current crisis, , they had been expecting an economic downturn and  were prepared to support their portfolio companies with both capital and operational expertise when times became difficult.

It is important to remember that private equity focuses on long-term value creation. The interests of the ultimate investors, the private equity manager and the business’ management are well aligned and the tight governance in private equity ensures that action can be taken if a portfolio company is not achieving its plan. Once the value creation strategy for a company has been successfully accomplished, the business is positioned for a profitable sale to a strategic or trade buyer or to another private equity manager, who has the skillset to take the business forward to the next stage of its development, or to IPO with everyone usually crystallising equity value at the same time.

Myth 3: Private equity managers do not prioritise ESG

On the contrary, “With a strong emphasis on stewardship, and close contact between the [private equity manager] and company management, private equity is naturally suited to responsible investment” according to the United Nations-backed Principles for Responsible Investment (UNPRI)[2], the world’s leading proponent of responsible investment.

From climate change and other sustainability issues to workplace diversity and beyond, increasingly investors are aware that careful management of environmental, social and governance (ESG) factors plays a significant role in the value creation and long-term performance of investments. It makes good business sense to mitigate against risks which may arise through neglecting ESG concerns and could lead to material or reputational damage. This responsible investing mindset has been highlighted further through the pandemic and we expect this heightened focus on ESG to continue.

Investors expect private equity managers to manage ESG-related risks effectively and many now run detailed ESG programmes to manage issues at both the portfolio level and the underlying companies.

Pantheon, which manages PIP and is a prominent investor in private markets, aims to make a difference and engages actively across the private equity community on ESG matters. As one of the first private equity signatories to the UNPRI in 2007, the core principles of responsible investment are embedded in Pantheon’s due diligence processes when assessing an investment opportunity as well as through the proactive monitoring of the businesses in PIP’s underlying portfolio for the duration of the investment. This continual assessment continues right until the investment is exited. Pantheon is also a leader in promoting diversity and inclusion – a belief that is also reflected on PIP’s Board of which three directors out of seven are female.

Investors must assess carefully what is right for them and their investment objectives. However, it is our belief that private equity has attractive characteristics and investors should consider including it as part of a balanced equity portfolio. PIP offers the opportunity to do this.

Important Information

This article and the information contained herein is the proprietary information of Pantheon International Plc (“PIP”); it may not be reproduced, amended, or used for any other purpose, without the prior written permission of PIP.

This article is distributed by Pantheon Ventures (UK) LLP (“Pantheon UK”), a firm that is authorised and regulated by the Financial Conduct Authority (“FCA”) in the United Kingdom, FCA Reference Number 520240. Pantheon UK is PIP’s Manager and receives a monthly management fee. Further information on the fees payable to Pantheon UK can be found in The Directors’ Report section of PIP’s latest annual report and accounts.

The information and any views contained in this article are provided for general information only. Nothing in this article constitutes an offer, recommendation, invitation, inducement or solicitation to invest in PIP. Investors may find listed private equity products other than PIP to be more suitable for their needs and objectives. Nothing contained in this article is intended to constitute legal, tax, securities or investment advice. You should seek individual advice from an appropriate independent financial and/or other professional adviser before making any investment or financial decision. This article is intended only for persons in the UK and persons in any other jurisdiction to whom such information can be lawfully communicated without any approval being obtained or any other action being taken to permit such communication where approval or other action for such purpose is required. This article is not directed at and is not for use by any other person.

Pantheon has taken reasonable care to ensure that the information contained in this article is accurate at the date of publication. However, no warranty or guarantee (express or implied) is given by Pantheon as to the accuracy of the information in this article, and to the extent permitted by applicable law, Pantheon specifically disclaims any liability for errors, inaccuracies or omissions in this article and for any loss or damage resulting from its use.

For more information regarding Pantheon, please consult our website: https://www.pantheon.com/legal-regulatory-notice/.

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[1] Listed private equity products are designed to be long-term investments and the returns from them can be volatile during their life. Investors should bear in mind that share prices can go down as well as up and that loss of principal invested may occur. In addition, the price at which PIP’s shares trade may not reflect its prevailing net asset value per share.

[2] Source: https://www.unpri.org/an-introduction-to-responsible-investment/an-introduction-to-responsible-investment-private-equity/4941.article