The case for private equity

As highlighted in previous pieces, private equity is assuming greater importance across the investment landscape as fast-growing companies find they have less need to go public in order to access capital for expansion. They may also not want the regulatory burden of listing. As such, the sector offers an increasing number of attractive opportunities – for example, the number of ‘unicorns’ (private companies valued at over $1bn) has risen tenfold over the last decade.

Meanwhile, for reasons including M&A and major shareholders taking companies private, the number of listed companies has declined by just over 2% a year over the last decade according to a recent report. This trend looks set to continue for various reasons, particularly in those markets looking cheap to bidders.

The sector’s modus operandi is to buy controlling stakes in good companies and then, through engagement and financial/investment discipline, turn them into better companies. Due diligence and detailed research are integral to the process. The interests of the management are aligned to that of the private equity managers, with rewards coming only on disposal. This tends to put long-term value creation ahead of short-term profits.

Such an approach suggests prospects continue to offer promising returns. When some public markets are looking fully valued, investing for the long-term in private companies offering more potential, while appearing attractively valued relative to prospects, should continue to produce superior returns.

Of course, bids by private equity companies for strategically important aerospace/defence companies require scrutiny. This is why Kwasi Kwarteng, the Business Secretary, is right to refer the bid for Meggitt to the Competition and Markets Authority on grounds of national security. The same applies regarding the bid for Ultra Electronics. However, overall, the sector’s record cannot be ignored.

For the typical investor, exposure to private equity is best accessed through investment trusts which, because of their close-ended structure, provide the ideal ‘incubator’ environment for such investments to flourish over time. This has helped investment trusts strongly outperform public markets over the decades. Furthermore, following the financial crisis of 2008, these trusts are conservatively financed.

Yet many good performing investment trusts still stand on 20%+ discounts. And these discounts may not be telling the whole story – they are often conservative in that a trust’s NAV will not reflect its full current value because, by the very nature of a private business, a significant element may be valued some months previously at a time when markets have been rising. Such discounts appear anomalous when compared to the wider investment trust sector and given their track record over time.

An example is HarbourVest Global Private Equity (HVPE) which is held in some of our portfolios. HVPE stands on an estimated discount of 23%, with 15% of the portfolio valued as at 30 September and the remaining 85% as at 30 June.

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