Is it time for ordinary investors to put money into private equity?

You don’t have to look far to see how dominant a force private equity has become during the pandemic.

Against a backdrop of low interest rates, institutional investors seeking higher returns have piled money into private equity firms that promise generous returns. The low interest rate environment has also made borrowing, which is central to the model, significantly cheaper.

Private equity firms have earned a reputation for being vultures, but the sector could represent a good opportunity for ordinary investors amid the public market’s volatility.

Aerospace company Meggitt has been the target of a bidding war by private equity firms amid a wave of takeovers in the UK

Aerospace company Meggitt has been the target of a bidding war by private equity firms amid a wave of takeovers in the UK

Is private equity a good investment?

Much has been made of the “dry powder” — the cash private equity firms they sit on — that have accumulated during the pandemic.

Research by KPMG shows that it was deployed quickly. Investment in the first half of 2021, both in terms of number of deals and value, has reached levels not seen since 2017. Around 785 deals were completed worth a total of £74.7 billion.

The UK has become a particularly popular target as buyout companies try to take advantage of low valuations. Targets included aerospace manufacturer Meggitt, defense company Ultra Electronics and supermarket Morrisons.

But these takeover bids represent only one segment of the private equity business.

“PE deals often involve PE companies that support companies that are already private, such as supporting a founder management buyout,” said Jason Hollands, director of investment platform Bestinvest. “These are incredibly consensual, with the people running the business meeting a roster of potential investors and choosing who to go with.”

The way deals are structured incentivizes management teams to create value for investors in a few years’ time, which some critics say leads to short-termism.

“While PE has an image problem and is often associated with instances of company asset stripping, many PE investments take a buy and build approach, funding a company to grow rapidly,” says Hollands.

While private equity can be an attractive option for those looking to reduce their exposure to market volatility, it is often accused of being an opaque and obscure sector for the average investor.

The minimum investment varies from fund to fund, but PE funds are generally structured as limited partnerships that last for a fixed number of years.

Limited partners, who are the outside investors, are liable for the entire amount they invest in the fund – which is usually over $5 million for institutional investors such as pension funds and college endowments.

High net worth individuals, who tend to invest at least six figures, also don’t need the same protection or access to their money as the average personal investor.

However, there are some ways for ordinary investors to access private companies, diversify their portfolio and take advantage of some of the funds’ high returns.

Listed venture capital companies

Investing directly in companies that manage private equity investments can be risky during periods of volatility.

But they can be a good prospect if you’re investing for the long term and don’t have deep enough pockets to buy into a fund.

However, there are few publicly traded management firms – the recently publicly traded Bridgepoint joins a handful of private equity managers, including Draper Esprit, Intermediate Capital and IP Group, as well as the investment trust 3i, which acts more like a PE manager.

“The shares of London-listed private equity firms are much more volatile than the average private equity investment trust,” said Mick Gilligan, partner at Killik & Co.

“Except IP Group, all of the larger publicly traded PE companies trade at significant premiums to book value, while some of the larger PE investment trusts still trade at a discount,”

“So a combination of both is probably more suitable for the more cautious private equity investor.”

Mutual funds

Investors looking to increase their exposure to private equity but are concerned about market volatility may want to consider investment trusts.

Some investors may already be inadvertently investing in private companies as investment trusts previously focused on publicly traded companies build exposure to them.

How else can I invest in private companies?

There are wider opportunities for investment in private companies in the UK, namely through venture capital funds (VCTs) and special acquisition companies (SPACs).

VCTs are investment companies listed on the London Stock Exchange that raise money to invest in young, mostly private companies or companies listed on Aim. Investors can claim an income tax reduction of up to 30 percent on the amount they invest in a VCT, provided they hold the investment for at least five years. Any dividends or gains on the shares are also free of tax.

SPACs were all the rage at the start of the year, with a handful of UK companies choosing to merge with one to go public. They raise money from investors through a public listing for the sole purpose of acquiring an existing company. Not wanting to miss the SPAC frenzy, the Financial Conduct Authority has been consulting about rule changes for these blank check vehicles.

Hollands warns that SPACs are risky and controversial. “The sponsors involved with them – including celebrities and politicians, as well as wealthy financiers and businessmen – also get a large share of the stock cheaply.”

F&C, the UK’s oldest investment trust, has just over 8 percent in private equity funds, while Scottish Mortgage has 21 private equity investments representing 21 percent of the portfolio.

Investors looking to increase their exposure can put money into a portfolio of underlying limited partnerships – essentially a “fund of funds” approach that gives them indirect access to a range of funds.

BMO Private Equity Trust and HarbourVest Global Private Equity are examples of this type of trust.

An investment trust can trade at a premium or discount to the value of its portfolio – read more here.

Matt Brennan, fund manager at AJ Bell, says: “A mutual fund is able to raise additional money and can therefore quickly take advantage of market opportunities. A direct private equity firm can do the same, but that often takes a little longer.’

One of the biggest benefits of investing in a trust is diversification.

“The manager’s job is to do the due diligence and support the best teams, but also to ensure that the portfolio is diversified across different strategies and regions,” says Hollands. “Like most funds of funds, you pay two tiers of fees, but the benefit is diversification.”

There are also investment companies that invest directly in individual deals rather than funds, such as HGCapital which invests in European software and technology companies. One of Bestinvest’s preferred funds is Syncona, which supports early stage life sciences and healthcare companies.

These types of trusts are significantly riskier than the fund of funds approach, as they focus on one or two specialist areas.

ETFs

For investors who prefer a passive option, the iShares Listed Private Equity ETF offers exposure to 66 companies, half of which are in the US. Top spots include Blackrock, 3i and KKR.

An ETF can offer as much diversification as an investment trust, but investors interested in private equity may prefer to be more selective.

“Diversification is partly about the number of holdings, but an active approach can also ensure that the portfolio is exposed to a good mix of strategies (buy-outs, growth funds, venture capital) and different vintages, so that you have a mix of younger funds. who make new investments, but also from funds that are approaching their maturity date’, says Hollands. ‘A passive approach simply weighs in on the largest listed private equity firms and funds’.

PERFORMANCE OF PRIVATE EQUITY INVESTMENT TRUSTS
Name Ongoing charges (%) NAV / share Total assets Transmission (%) Discount (%) Dividend Yield (%) 1J Share price Total return Performance (%) 3J Share price Total return Performance (%) 5J Share price Total return Performance (%) 10Y Share price Total return Performance (%)
3i Group 1.26 10.42000 11.115.474.090.74 7.08 28.31 2.88 47.78 57.45 148.06 783.20
Apax Global Alpha 1.57 2.28695 1,123,120,936.97 0.00 -4.89 4.67 41.70 92.21 128.83
BMO Private Equity 1.23 4.78031 424.643.189.08 18.29 -8.06 3.67 37.28 49.87 118.23 309.75
Dunedin Enterprise 1.32 4.93240 101.824.771.41 0.00 -15.05 0.48 44.32 39.32 150.83 209.10
Electra Private Equity 1.80 5.14300 200,439,831,05 0.00 14.33 0.00 204.27 40.35 114.97 468.86
HarbourVest Global Private Equity 0.41 29.21000 2,332,783,216.06 0.00 -19.72 0.00 48.42 74.48 154.20 400.49
HgCapital 1.56 3.35120 1,471,360,472.57 0.00 21.75 1.23 63.59 129.95 247.06 390.95
ICG Enterprise 1.42 13,99732 959.055.144.29 0.00 -16.41 2.31 47.06 46.94 120.73 304.92
JPEL Private Equity 1.29 2.0000 165.035.538.00 0.00 -16.25 0.00 56.54 16.60 77.47 86.11
Literacy Capital 1.83100 109,860,000.00 0.00 30.53
LMS Capital 5.84 0.59058 47,676,017.42 0.00 -39.04 2.50 15.40 -22.30 -29.06 -34.73
NB Private Equity Partners ZDP 2022 2.33 1.21212 1,100,099,295.26 7.11 0.65 0.00 6.55 8.93
NB Private Equity Partners ZDP 2024 2.33 1.14254 1,100,099,295.26 13.85 0.21 0.00 8.53 9.57
NB Private Equity Partners Ord 2.33 19,38667 1,100,099,295.26 21.02 -20.31 3.38 78.93 58.93 130.26 346.13
Oakley Capital Investments 2.46 4.55004 795,669,858.88 0.00 -20.99 1.28 38.41 92.85 209.73 346.13
Pantheon International 1.21 35.21900 1,904,976,233.89 0.00 -21.21 0.00 28.77 36.03 93.38 303.34
Princess Private Equity Holding 1.79 15.24000 1,053,863,800.32 0.00 -11.58 4.30 58.19 58.40 132.28 334.01
Standard Life Private Equity 1.14 5.68232 873.635.641.32 0.00 -19.84 2.99 47.41 52.88 130.79 301.40
Symphony International Holdings 2.98 0.79150 409,059,345.72 0.59 -44.41 6.87 57.14 -35.58 -17.67 3.03
Industry Averages 1.27 4.31 10.98 2.83 48.58 59.13 135.90 479.71
Source: AIC/Morningstar

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