Many retail investors have overlooked the listed private equity sector in the past, but the strong performance of private equity relative to the public markets and wide discounts on listed private equity shares make it worth a closer look.
The private equity market has been growing steadily over many years, and now has an estimated $4.4 trillion of assets under management spread across all the main regions of the world. The unlisted companies that its specialist managers select and support have the potential to generate higher returns than in the quoted markets, and they provide a wider investment opportunity set to investors.
The best private equity managers achieve higher investment performance through active involvement with their investee companies. They will typically acquire a major stake in a private business and may participate in additional rounds of fundraising to support the company further as it grows. However, the companies do not just benefit from the capital injections alone. Private equity managers are long-term investors, usually represented on the boards of the investee companies, who apply their deep-rooted sector, operational and strategic expertise, thereby playing an instrumental role in improving the future prospects of the business.
Institutional investors, such as pension funds, have been steadily increasing their allocations to this asset class, in search of higher returns and diversification. However, private investors are typically under-invested in the sector. Some of the reasons for this are that private investors are not able to access private equity managers directly and many may not have the high minimum amounts or the long timescales required for investment; or they may not have the expertise required to invest in and manage assets of this nature.
However, there is an alternative route into the asset class. Private investors who want to benefit from the exciting growth potential offered by the private equity market can take advantage of these opportunities via a listed private equity company. Listed private equity companies are well-established in the UK: the first private equity investment trust was launched in 1976, but there are now 22 with total assets of £18.8 billion, according to the Association of Investment Companies. These funds are able to reinvest the proceeds from the sale of their investments free of capital gains tax into new investments, thereby compounding the returns and providing shareholders with long-term capital appreciation. The closed-ended structure is ideal for such an illiquid asset class with the investment trust shares traded daily with no impact on the underlying portfolio holdings.
The public markets are shrinking in terms of the number of listed companies by around two percent per annum, whereas the number of private-equity backed companies is growing by about eight percent per annum. Recent analysis by Preqin forecasts that the global private equity market could more than double in size from circa $4.4tn today to over $9tn in 2025, which suggests that more investors need to include private equity in their portfolios.
Accessing private equity through an investment trust with a strong track record
One way to gain access to a global, diversified portfolio of high-quality private equity assets, is to invest in Pantheon International Plc (LON:PIN), otherwise known as “PIP”. A FTSE 250 company, PIP is a well-established vehicle that has assets under management of £1.6bn, which it has grown through investing in a carefully selected portfolio of private equity funds as well as investing directly into private companies alongside many of those private equity managers. PIP is managed by Pantheon, a leading global private equity investor which has almost four decades of managing private assets through multiple cycles.
Helen Steers, a Partner at Pantheon and manager of PIP, says that although PIP is sometimes viewed as a fund-of-funds, it is differentiated from its listed fund-of-funds peers as it invests directly into the deals that are sourced for it by Pantheon. According to Steers,
“PIP participates as a direct investor in private equity funds and privately-owned companies (through co-investments), which means that it retains full control over portfolio construction and investment deployment. It has the flexibility to increase or decrease its allocations to deals according to the investment strategy and pacing that has been agreed with the Board, which is fully independent from Pantheon.”
Since inception in 1987 to the end of October 2020, PIP has generated 11.6% average annual NAV growth. This is net of all the costs and represents around four percent annual outperformance compared with benchmark indices and is about one-and-a-half times the market level of returns as measured by the FTSE All-Share. As Steers explains,
“PIP has built up significant expertise in selecting the best PE managers worldwide and our seats on over 460 advisory boards enable us to gather privileged information and access compelling deal flow. We are considered a highly experienced reference investor and a respected counterparty when negotiating with managers and are influential in shaping deals.”
Many private equity funds are heavily exposed to the technology and healthcare sectors, which have been some of the strongest performing areas during the pandemic. PIP is no exception with just under half of its assets on a look through basis committed to this part of the market.
The trust has been tilting its portfolio towards technology and healthcare for some time. Even before the onset of the coronavirus crisis, PIP’s underlying private equity managers had identified certain attractive themes, including the growing requirement for greater digitalisation, process automation and mission-critical enterprise software that have driven investment decisions. Steers adds:
“In healthcare, the secular trends have also been favourable, with ageing populations in the developed world and increased demand for specialty pharmaceutical products and services. So, we have been adding to our exposure in the medical care, testing, diagnostics, pharmaceutical and health tech areas.”
Possible buying opportunity
During the broad market sell-off in March, investment trust discounts widened right across the board, but since then the performance has been mixed with some sectors recovering more quickly than others. Those with illiquid underlying holdings have suffered more than most, with the listed private equity trusts still trading on a wider average discount than they did at the start of the year.
The picture is further complicated by the fact that many listed private equity funds typically only provide full valuations twice a year, with all the other updates just reflecting the movements in the relevant exchange rates and actual realisations. However, at the start of the pandemic, PIP adjusted its reported NAV for March to reflect Pantheon’s view of the potential impact of the COVID-19 crisis on investment values within PIP’s portfolio, basing this assessment largely on guidance obtained by Pantheon following extensive review meetings with the underlying private equity managers. This was a reflection of the strength of Pantheon’s relationships with its PE managers, which meant it was able to obtain this guidance, but also of PIP’s commitment to providing investors with transparent and up-to-date information.
Some commentators believe that the listed private equity sector offers real value at the moment. This is because the resilient nature of many of the underlying companies means that they are well placed to have weathered the pandemic.
PIP is currently trading on an approximate 24% discount to its October NAV, which itself is largely based on the underlying valuations conducted at the end of June and if anything is likely to be understated. Steers says,
“I don’t think that the discount is justified. Shareholders are getting access to a well-managed portfolio, which has held up well through several economic cycles over PIP’s more than 33-year history and indeed we are backing managers who themselves have managed assets through multiple cycles. The 28% average uplift achieved on exit, which we reported at our year end at 31 May 2020, provides further evidence to support this view. This is the average uplift compared with the value of the underlying company 12 months prior to the exit and is consistent with the uplifts that we have seen over previous years, which demonstrates the embedded value in PIP’s portfolio.”
The share prices of many listed stocks have been extremely volatile throughout the year with COVID-19 winners in the technology and healthcare sectors typically doing very well, although some of the cyclicals have recently started to catch up following the positive news about the vaccine trials.
Most businesses will have been challenged in one way or another, but those with private equity backing can call on the expertise of the private equity managers and may well be able to approach them for extra funding if required. The long-term nature of private equity funds means that everyone is in it together and the PE managers will do all they can to support their investee companies.
Fund in focus
Pantheon International (LON:PIN) is one of the listed private equity companies recommended by the broker Numis. It offers a diversified exposure to global buyouts, growth capital and venture capital and since its launch in September 1987 has generated impressive average annual NAV growth of 11.6%.
PIP’s portfolio is weighted towards the more developed private equity markets in the USA and Europe, with these two regions accounting for 81% of the assets at the end of August. The remainder is invested in the faster-growing economies in Asia and the Emerging Markets.
It is also well diversified across different investment stages with a particular focus on small/mid-market buyout and growth funds and across the different types of private equity investment, which helps to smooth out the returns and cash flows. The effective management of the maturity profile ensures that it is not overly exposed to any one vintage.
Numis likes the fact that PIP’s portfolio is well-managed and diversified and says that the fund is well capitalised to take advantage of potential opportunities, while its over-commitment level remains the lowest in the peer group.
The level of portfolio activity has picked up in the third quarter and PIP has a full pipeline of deals, which indicates an active period for new commitments in the months ahead.
This article was sponsored by Pantheon International Partners.