Private Equity Investment Trusts

TCA

I'm considering risking a small amount (maybe 5% of total investments) in a private equity investment trust. Partly for diversification and partly because I like a bit of a gamble.

I've done a very quick analysis using the AIC website and haven't delved into the nitty gritty of the trusts themselves, but would be interested to hear any views on this particular asset sector, specific trusts, etc...

So far I've trimmed down the AIC trust listing based on SPTR, dividend yield ( I like income), 5 year dividend growth, fees, discount/premium and I've stuck to sterling denominated shares. My final four based on those factors are:

JZ Capital Partners (JZCP) - Quasi Split Capital Trust, 17% gearing, 100% USA, OCF 3.48%, 26% discount, 4.2% yield, 14% p.a. five year div growth

F&C Private Equity (FPEO) - Quasi Split Capital Trust, 23% gearing, 83% UK/Europe, OCF 1.54%, 13% discount, 4.6% yield, 67% p.a. five year div growth

Dunedin Enterprise (DNE) - Closed End Fund, 100% UK, OCF 1.16%, 16% discount, 3.9% yield, 46% p.a. five year div growth

Standard Life European Private Equity (SEP) - Closed End Fund, 100% Europe, OCF 0.97%, 11% discount, 2.2% yield, 119% p.a. five year div growth

My thoughts based on the above:

The returns on JZCP look a bit erratic over time, actually show a negative performance since launch on Trustnet and nearly wiped themselves out completely in 2008. Coupled with the high charges and the fact I'm not convinced about investing in the US at this time, leads me to rule this one out.

F&C and Standard Life European both trump Dunedin for returns but Dunedin has a better annualised return since launch and fared much better than the other two in 2008. F&C and SEP have both returned over 200% over 10 years, compared to Dunedin's 115%, and they both do better over any period less than 10 years, with income reinvested. Despite their longevity, over the last 6 months Dunedin appears to have a pretty torrid time of it (I'll try to find out why), and although they've done well in the last month or so, I think I'll need to dig a bit further for some convincing.

Re F&C, I'm not sure whether gearing is a benefit or hindrance (especially at 23%) and will investigate the dynamics further. I do like its high yield and it has a commitment to provide both capital growth and above average dividend. Standard Life European has a considerably lower yield with an objective of long term capital gains, so no income focus despite substantially increasing dividends since 2012. Its portfolio is 100% Europe.

So after a very rough and ready analysis I'd maybe plump for F&C Private Equity.

I'm now going to delve under the bonnet of some of these trusts (including ones I've spuriously ruled out) to see the composition of their portfolios and investment timeframes. Meantime it would be great to hear any and all views on the subject and whether I've ruled out anyone's favourite private equity trust in my hashy first bash at whittling down the options.

Cheers in advance

TCA

jimjames

I've used Graphite Enterprise for many years and been very happy with them. Discount went to crazy levels in 2008-10 which mean I got some bargain shares but it has dropped again now.

Thrugelmir

My concern with PE is that it's getting more difficult for the fund managers to exit. In that the owners are finding it more difficult to float or sell the business on. Too many PE stock issues are being listed with high debt levels. Resulting in little appetite on the open market.

TCA

jimjames wrote: »

I've used Graphite Enterprise for many years and been very happy with them. Discount went to crazy levels in 2008-10 which mean I got some bargain shares but it has dropped again now.

Thanks Jim. Graphite Enterprise is one I've seen recommended several times and is one I should look at in more detail. It was 5th on my list and was marginally excluded because of its lower yield, which admittedly might be a factor I'm attaching too much importance to. The other area of concern was the fact that the discount had slipped to 30% at one point in the last year, which started some alarm bells ringing. One for closer inspection though.

atush

jimjames wrote: »

I've used Graphite Enterprise for many years and been very happy with them. Discount went to crazy levels in 2008-10 which mean I got some bargain shares but it has dropped again now.

I have been investing in this monthly for well over a decade. Up 112% int he last 5 years. I'm happy. historic yield is 1.25% I think

This plus some money invested in my OH's company is all my PE exposure.

TCA

atush wrote: »

I have been investing in this monthly for well over a decade. Up 112% in the last 5 years. I'm happy. historic yield is 1.25%.

Thanks. Another vote of confidence for Graphite. Hard to argue with returns like that. I just wonder if I've missed the boat a bit.

bowlhead99

A few thoughts for you TCA (warning long post ) :

TCA wrote: »

I'm considering risking a small amount (maybe 5% of total investments) in a private equity investment trust. Partly for diversification and partly because I like a bit of a gamble.

Why only 'a' private equity trust? Unless your total portfolio is very small, pick a couple, or one with broad holdings.

As you've said, one of the goals is diversification and one of them is a gamble: exposure to a new sector with different properties to more traditional listed investments. If you bought 2 PE trusts you would still achieve those without having 'eggs in one basket' to the same extent.

You are unlikely to be able to predict which single one of the five investments above, or of another good five candidates in the sector, will perform the best. Whereas if you pick a couple you have a better chance of being able to manage your geographical exposure to a ratio you're happy with (e.g. rather than having to be UK-centric or Europe-centric or US-centric, taking the exposure from just one manager of choice)

So far I've trimmed down the AIC trust listing based on

SPTR

Make sure you are not just looking at the last 5 years then. When the credit crunch hit, discounts to NAV in the listed private equity world opened up hugely, because of the extreme illiquidity of the assets, and the perception (in some cases justified) that some of them may not be able to meet ongoing commitments to investees and would have to sell off some holdings at a good discount to fair value.

Since that point, discounts have narrowed considerably so the return from a share price perspective will well exceed the return from a NAV perspective. SEP share price for example has done 400% in the 5 years to 31 March, but the underlying asset values, while also improving significantly from the values at the bottom of the credit crunch, can not have done that. And nor could you possibly expect to get that level of return of share price or NAV over any normal 5 year period.

So, using share price growth or SPTR to make a selection, if you do it over a period of tremendous share price growth, perhaps just means you're selecting the ones that got hit hardest by the crunch.

dividend yield ( I like income)

You might like income, but typically though, private equity managers are not really in the game of generating high income yields from their assets. Compared to public market investment, the PE guys are instead willing to invest and hold for a longer-term return as the investee's prospects grow or improve under a development and exit plan.

Likewise the big institutional investors who participate in private equity partnerships (which are often run in parallel with these types of trust) do not necessarily need income, just periodic cashflows from asset exits that can be ploughed right back into other funds.

The cash that comes out of the investees will be a mix of return of capital, hopefully some gains on top, and a bit of income. The proportion of the cash that represents income is not usually massive. And really they want to reinvest whatever cash they can rather than taking cash off the table.

I guess if they are a UK investment trust they need to pass on their income but the percentage yield won't be particularly high. If they are not an investment trust (e.g. a Guernsey investment company like JPEL or HVPE) they may not pay any dividends at all, but that doesn't imply they are any less safe as an investment.

Looking at some policies implemented by these listed fund-of-fund private equity vehicles over the last few years - they do understand that retail investors like income and paying nothing is not going to help narrow the discount. So some like APEF now have a policy of distributing a fixed percentage of received distributions on to their investors as a dividend and only leaving say 90% for reinvestment. Some like HVPE do not pay divs but have helped out their investors by instigating a program of redeeming shares at NAV. Some like JPEL have announced creation of a 'distributing' share class alongside the main one where proceeds do get passed on to the investors instead of being reinvested.

So generally PE vehicles for retail investors get the message that investors like a bit of cashflow rather than purely the compound growth, but nobody is paying long term sustainable sky high dividends. The nature of the activities means you can't really guarantee that you will generate say 4-5% income in a specific year.
Obviously if you just look at last year's div versus a current share price then a yield might look large, but won't necessarily be that way next year. Something like SL Capital's SEP at 2ish% sounds about right to me really.

5 year dividend growth

Again the 5 years is a bit flawed. You mention SEP at over 100% annual dividend growth. If I have a year where my income dries up and divs are nil, and then the next year I can pay a normal 1p again, my dividend growth is infinity percent. But it is not going to continue into the future like that because there's no way I can give you infinity pence the next year. Likewise SEP is not going to stay on that same 'dividend growth' curve and be paying out 50% of its share price in divs in a few years.

fees,

Fees are important, but generally NAV return after fees over say 10 years or so is more important to me than how much gets paid.

Typically the private equity structure has fixed annual management fees and performance fees ("carried interest") and if you are accessing the sector through fund-of-funds (the only way to really get a decent spread across the sector) you will be paying quite a chunk of the underlying headline returns to management. Either the manager of the fund of funds, or the underlying managers deploying the cash into the private businesses. It is not always as clear as it could be, how much total fee you are exposed to.

However, as you couldn't access those headline returns on the public markets (because the businesses are private), the entrance fee is a necessary evil and it is hard to shop around and eliminate it without closing off perfectly valid investment opportunities.

discount/premium

Discount/premium can be hard to monitor properly.

Private equity assets are not properly valued more than once a quarter and sometimes only once every six months. In the interim months you are usually left with a simple roll-forward of money in and money out of the different deals with some accounting for a general indexing up or down or known realised gains that exceeded or fell short of the last valuation. And a very small percentage of assets that were liquid and listed somewhere. And where a full valuation is actually done, it isn't going to feed through into accounts reported to the market until some time later (particularly a problem with fund-of-funds).

So in SEP's latest trading statement and factsheet, March 31 it said NAV was 252p and share price was 204p - a 19% discount. However, today over two months later the price is 225p. Does this mean the discount is now 11% as you suggest? You don't actually know what today's NAV is.

A further point on discount - remember the holdings are illiquid and the fund manager cannot sell them for NAV.

Sure, there is a valuation process that says what a business is worth compared to listed comparables and takes into account other relevant factors. But if a manager wants to try to get that value today, and has not already started the due diligence process with a buyer a few months back, he is only going to be able to achieve a "fire sale" price. And there is no concept of simply being able to cash in x % of his holding in ABC plc.

Similarly if you are looking at a fund of funds like SEP or FPEO, the holdings are non-redeemable stakes in private partnerships, with commitments to put more cash in over time. If the FOF manager wants to cut down those commitments he needs to find someone to buy his second-hand holding in the partnership and in most situations you would expect that to be at a discount to the NAV he reported to you in his last factsheet.

So, except in massive boom times in the markets as a whole - where people are desperate to get their cash deployed into a reputable entity - these things are not likely to be trading at a premium if they have a broad exposure to risk and illiquidity. It is entirely valid for a PE vehicle to be trading at a discount over the long terms with just the depth of that discount varying. 10-20% could be about right.

It's great to be able to buy assets for less than their underlying worth (it offsets some of the fees you're paying), but IMHO you shouldn't bank on a 15% discount magically turning to a 10% premium when the strategy is back in favour, as you might get with some other trusts (e.g. listed emerging markets).

I've done well by buying PE vehicles when well out of favour, for example back in March 2012 I was buying HVPE at $6.60 against an $11.40 NAV (43% off). Now a couple of years later it's at $11.30 against $14.30 NAV (only 21% off). So the fund went up by 25% but I've made 70% in the same period (in dollar terms, a bit less in sterling). However, I can't assume the discount will narrow by that remaining 21% over the next couple of years. I think there's scope for it to narrow a bit more but generally it's the quality and breadth of the underlying assets that I'm keeping it for, rather than a discount recovery play.

I've stuck to sterling denominated shares.

Having a listing in sterling only really saves you the odd percent or so on forex fees when buying or selling and is not particularly important long term IMHO.

What is probably more important is where the underlying assets are located which drives your exposure to currencies and markets. So for example the F&C trust you mentioned, had per their December '13 annual report, around £200m of net assets, but the assets themselves were principally invested by fund managers in Europe and the US; £105m exposure to EUR, £12m in NOK, £30m in USD. Of course some of the EUR investee funds will in turn hold GBP assets again but others will be plays on Germany or France or Benelux or whatever.

Likewise the JZ fund has lots of holdings in US and Europe, supported by borrowing in sterling. Once the borrowings are considered the net GBP assets are negative.

So looking at 'what price something is listed in' can be a red herring. If I am buying a portfolio of international companies that I want to hold for 10 years, and overall their aggregate value converted to sterling today is £10,000, I don't particularly mind whether I pay £10,000 or USD 16,800 or EUR 12,300 for the units in that fund. If I take the latter two options it might cost me £10,100 because of a 1% FX fee, so I would prefer to buy and sell in GBP, but really that should not dissuade me too heavily from the non GBP opportunity.

After all, I am looking at picking a manager whose goal is to get me a 7%+ annualised return and so I hope to end up with £20,000+ after a decade or £40,000+ after two. Forcing myself to buy the SEP fund-of-fund over HVPE because the former is priced in sterling completely misses the big picture, which is that HVPE has two thirds of its assets being deployed by North American managers (the largest private equity market in the world) while SEP is a European fund and does not.

If I was comparing Pantheon's PIN to Harbourvest's HVPE, where the former also has 50%+ of its assets in North America, and I couldn't pick between them at all, I would be tempted to go PIN because it's priced in GBP and I might save a little in FX costs. But PIN does have 10% more of its assets in Europe than HVPE and a different mix of venture versus buyout, so it's still not an apples to apples comparison.

My final four based on those factors are:

They are quite different beasts.
JZ holds smallcaps/microcaps in the US and Europe (100% USA is not correct although it does have 3x as much Dollar exposure as Euro exposure). It also has some real estate opportunities.

Dunedin is investing in quite a small number of portfolio companies alongside other institutional funds managed by Dunedin. So it is highly concentrated and only investing in whatever deal opportunities Dunedin make for themselves. That explains why there was 25% of the portfolio in cash at the last count. This undeployed cash would seem to be an inherent drag on IRR performance, compared to a fund-of-funds which holds very small levels of cash and is always throwing cash into several underlying managers' funds as it gets cash back from others, keeping a finance facility to ensure it doesn't get caught short. However, a highly concentrated portfolio can give great returns if all the deals come off.

SEP and FPEO are more generalist fund-of-funds which will have exposure to mid-market buyouts and larger deals which Dunedin and JZ wouldn't do. Both will probably have some direct co-investments into individual companies, alongside their fund exposure. Graphite has some direct deals headed up by the Graphite team (like Dunedin) and then also a bunch of fund investments like SEP where the holdings are looked after by other managers. This spreads your exposure nicely while still having some proprietary deals.

Others you could consider, as I mentioned, include HVPE, PIN, or JPEL (JP Morgan branded, managed by the ex-Bear Stearns team) which have very broad portfolios albeit with different regional splits. Aberdeen/SVG's APEF is another I have but with more concentration into fewer funds than those three.

As an example, at last year end, HVPE had exposure to 6200 underlying companies through all the funds in which it participates. Some of these will be duplicates, for example it had exposure to the Facebook and Twitter IPOs through several venture funds who had participated in various early funding rounds. But you get your fingers in a lot of pies with a fund like that. You are really investing into the strength of private equity as a concept, rather than punting on individual companies a la Dunedin.

So if your porfolio includes a global tracker for public listed equities, you could almost think of HVPE as a proxy for a tracker of unlisted equities - they invest with a large number of reputable underlying managers with great diversification across industries, geographies, vintage year of original investment into the underlying companies, etc. Sure, compared to the listed world, private equity has high fees because the 'majority ownership of a private enterprise' model is on the exact opposite end of the cost scale from investing a little bit into every listed company using an index. But I generally think the advantages of PE outweigh those costs and if it is on a 20% discount it works for me.

I have circa 15% of one of my SIPPs and a good chunk of ISA money in funds like this.

melbury

How do these differ from ordinary Investment Trusts? Just wondered......

dale_cotterill

melbury wrote: »

How do these differ from ordinary Investment Trusts? Just wondered......

The companies they invest in are not publicly listed.

bowlhead99

melbury wrote: »

How do these differ from ordinary Investment Trusts? Just wondered......

Dale has the perfect answer but to expand...

Well... an investment company holds a portfolio of assets and people can buy a share in the company to gain exposure to the assets and profits and losses of the portfolio.

Unlike an open ended 'fund' like an OEIC or Unit Trust, if someone else wants to come in and buy a share in the investment company they don't just issue new shares at the current net asset value per share - you have to buy it off someone else in the market during trading hours. When buying or selling that share in the market,
depending on supply and demand, you might be able to buy at a discount to - or you might need to pay a premium to - the current underlying net asset value of the piece of the investment company that each equity share really represents.

Within the world of investment companies, investment trusts are UK registered companies which meet certain conditions set by HMRC which mean that they don't pay tax on the gains within the portfolio.

So an investment trust is just a type of investment company. Investment companies and investment trusts can hold a variety of different assets, which range from publicly listed shares and bonds and commodities to shares and loans and bonds of privately owned businesses, or even other investment companies.

The ones we are talking about here, "private equity" are investment trusts or investment companies which specialise in making investments in private businesses rather than fully listed businesses. The investment trusts or investment companies will generally own shares in the businesses alongside other institutional investors. They will either own them directly or take positions in a portfolio of larger funds or partnerships - collective investment schemes which in turn each own a portfolio of private businesses.

Then at some point the companies or funds owning the private businesses will exit their holdings by, for example:

- selling the business to a trade buyer (eg Boots was a public company which was taken over by a consortium of private equity groups before being partially sold to Wallgreens a few years later);

- or to another private equity group (e.g. Graphite Capital sold Wagamama to Lion Capital who held it for 5 years or so before selling it on to Duke Street Capital);

- or float it on the stock exchange (for example Saga and AA were owned by private equity groups who are floating them on the London stock market again this summer).

Private equity encompasses everything from the Dragon's Den guys putting some seed capital into a business idea, to venture capitalists providing a few millions or tens of millions in funding in exchange for part-ownership of Facebook before it grew and went public, to KKR buying Alliance Boots for €15bn a few years back to run as a private concern away from the pressures of public ownership.

Within the private equity world, most of it is very private ownership by specialist fund managers putting funds together for collective investment by large institutions and high net worth individuals. However, some of the funding in the sector comes from listed private equity vehicles that you or I can buy a piece of on the stock exchange.

Some of these vehicles will be investment trusts (for example Standard Life European Private Equity Trust is a fund-of-funds investing in private equity). As mentioned, investment trusts don't pay tax to HMRC on their gains, so you can own them without being exposed to two layers of tax. But there are other investment companies which behave quite similarly but can't be investment trusts because they are not based in the UK (for example, I mentioned HVPE and JPEL and APEF which are based in Guernsey and are also funds-of-funds investing in private equity). However, as they're in a tax neutral domicile they don't pay tax on their gains either.

But basically, if you follow the above you'll see that:

1) Private equity is an asset class that you might invest in through an investment trust or an investment company. In fact that's pretty much the only way you can get exposure as an individual with a normal sized wallet. So in this thread we are talking about investment trusts or investment companies that invest in this asset class.

While

2) an investment company or an investment trust is not an asset class in itself, it is a way of holding an investment. Some investment companies and investment trusts will hold private equity. Some will hold shares in public equities. Some hold bonds, gold etc. etc.

So, asking "what's the difference between private equity investment trusts and normal investment trusts" is a bit like asking "what is the difference between a ham sandwich and a normal sandwich". You eat a ham sandwich just like a normal sandwich except what you end up eating in the middle of the sandwich is ham rather than cheese, chicken, beef, salad etc.

So ham sandwiches are a niche within mainstream lunch options. You might really love ham and want to buy a lot of it. Or it might upset your stomach so you don't want to risk any of it. Or you might be a conscientious objector on the grounds of some funny morals or religion. Or you might think it is OK and you will have a bit as part of a balanced diet along with everything else.

Generally you find that private equity is harder to understand because it is opaque and less transparent than knowing from day to day that the investment trust owns 100k shares of Tesco plc and 50k shares of Sainsbury and 10k shares of ABC plc which are all individually listed on a public market. Combining the relative complexity and valuation difficulties with some gearing and the discounts / premiums that investment trusts come with as standard, means it is not mainstream and sits squarely within "alternative assets".

So I guess you could say the difference between private equity investment trusts and 'normal' investment trusts are that the normal ones invest in more mainstream stuff (like the tesco shares or the smaller listed companies shares or the european listed shares or the emerging market listed shares or the worldwide listed shares), while the private equity ones are down in that specialist private equity niche. But really it is just another specialism. I prefer the lunch analogy which reminds me it's time for dinner.
:beer:

Totton

If buying a PE holding now I would go for SVG Capital or HG Capital.

Currently my own private equity cover choices are RIT Capital and SVG Capital.
SVG was a recommendation from some IT analysts for 2014 whilst RIT has been a good holding as a core fund with a private equity element. RIT is pretty much a whole portfolio in one. Recent returns have not been great for RIT but the discount has drifted away from its long term premium which may make it a good choice at the moment. Having said that, Caledonia is my current top dog with its narrowing discount after being on a large discount for a long time.