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The word “discount” is one of the most attractive words in the English language.
But in the case of private equity investment funds, the discounts are currently causing more suspicion than enthusiasm.
The share prices of many of these trusts – which back unlisted companies poised to become the stars of tomorrow – are at a huge discount of up to 40 per cent to their net asset value (NAV).
These trusts can provide useful exposure to thriving companies (in financial services, retail and technology in the UK, US and Europe).
But the magnitude of the discounts is such that many conclude that private equity trusts are cheap for a reason, rather than being one of the best buys of autumn 2024.
Opportunity: Charlotte Morris (pictured) is co-director of the Pantheon International Partners trust
The level of mistrust is such that some even look askance at the only trust in the sector which commands a whopping 56 per cent premium to its share price and has delivered a return of 1,070 per cent over the last decade.
This is 3i Group, a FTSE 100 company founded in the post-war period as Investors in Industry.
Today, the £32bn trust is best known for its 58 per cent stake in Action, the convenience store chain with 2,725 outlets in 12 European countries.
But is the gap in our understanding of these trusts as big as that of some of the discounts? Ben Yearsley of Fairview Investing argues there is a “disconnect” between reality and market perception. “Over the long term, these have been very good investments, although you need to buy them for about a decade,” he says.
Charlotte Morris, co-director of the Pantheon International Partners trust, highlights the breadth of opportunities available.
“We are investing money in growth-oriented companies that operate in defensive and non-cyclical sectors, which benefit from long-term trends such as demographic aging, automation, digitalization and sustainability,” he said.
Pantheon’s portfolio includes companies such as Smile Doctors, a growing US orthodontic chain, Altamont Capital Partners, and a small portion of Action shares. If you prefer to be brave when others are fearful, you may be intrigued by the potential for diversification that private equity trusts offer, especially after reforms to cost disclosure rules that made their fees appear prohibitively high.
Furthermore, finance-hungry companies favored by private equity funds should be boosted by further falls in interest rates. The high cost of loans has been one of the causes of the magnitude of the discounts.
But you must be prepared for a journey into unknown territory.
Very few of these trusts’ investments have names you might recognise, although £1.7bn HarbourVest Global Private Equity (HPVE) holds a small stake in Shein, the controversial Chinese fashion giant reportedly poised for an exit to 50,000 million pounds on the London Stock Exchange.
HPVE, the sector’s second-largest trust, is discounted by 43 per cent, down from 52 per cent in March last year. But while most private equity-backed companies may be obscure, they aren’t necessarily struggling.
James Carthew, of research group QuotedData, points to MSCI Burgiss figures showing that the profits of management buyout companies have grown faster than those of the average listed company in nine of the last ten years.
One reason for the widening of discounts is the belief that trusts are too optimistic about the valuations of their holdings, leading to disappointment when these holdings are sold or seek a stock market listing.
Analysts disagree.
Carthew says: “Overall, valuations in the sector tend to be conservative.”
Iain Scouller of Stifel adds: ‘We expect sales of these funds’ portfolio companies to recover over the next year.
“Typically, when an investment is sold, it makes a profit of 20 to 30 per cent above its previous valuation, resulting in an increase in the net asset value of the trust.”
However, valuation questions are likely to continue. Hedge fund ShadowFall, run by Matthew Earl aka ‘The Dark Destroyer’, is shorting 3i shares on the grounds that the fund is taking an overly optimistic view of Action. The £14.8bn stake represents 72 per cent of the portfolio. Earl maintains that 3i values the chain at 18.5 times earnings, compared to the average of 14.4 times for this type of retailer.
The evaluation of The Dark Destroyer is disputed, of course, with some praising Action’s strength and prospects.
Carthew notes that ShadowFall’s claims “contradict all evidence of Action’s impressive growth record.”
But he wonders whether 3i should consider taking its stake in the chain to distribute some cash to shareholders and look for other companies that might be poised for greatness.
After all, Action’s share of 3i is worth 120 times more than it was when the trust first saw the chain’s potential in 2011.
The dispute over Action will continue, although there will be significant interest in the possible sale of 3i’s majority stake in pet food group MPM, maker of brands such as Applaws for cats.
Meanwhile, analysts are still predicting a further rise in the trust’s shares from the current 3,300p to 3,500p. This compares with 1993p in November last year, when 3i appeared in this column.
At that point, I took my own advice and put some cash into shares of this trust. I’m still on board because the argument about Action’s value seems to have entertainment value.
Among the options of sector experts is Hg Capital, which is the largest European investor in software companies. There is a 2.5 percent discount on this trust that prefers companies where executives have invested some of their own cash in the company. The shares are at 518 pence. Analysts’ average target is 540p.
Yearsley likes Pantheon, which is 34 percent off. Its shares are at 318.5p, but analysts are forecasting a rise to an average of 395p.
He is also a fan of NB Private Equity, which is at a 25 percent discount. This trust has a small portion of the popular retailer Action, but is mainly focused on the United States. Analysts’ average price target for the stock, which is currently trading at 1,532p, is 2,374p.
Carthew cites Oakley Capital Investments as one of his favorites. The trust, whose discount is 30 per cent, focuses on digital consumer, education and technology companies, taking advantage of some bargains in these sectors in recent years. The shares have risen between 10p and 500p so far this year. But analysts are pointing to a rise to 656p.
BestInvest’s Jason Hollands believes HarbourVest Global Private Equity has the potential to generate solid returns.
The current share price of the trust, which employs several teams of managers to locate the best deals, is 2,335p, but analysts have set a target of 3,796p.
Some of this optimism is likely to arise from the conviction in some quarters that the discount is ridiculously large and that the markets will realize this and change their minds.
The prospects for this and other private equity funds are certainly better than before, with more stakes likely to be disposed of at decent prices.
There is no schedule for the reduction of discounts. But while you wait, you’ll back growing companies, acting like a venture capitalist from the comfort of your armchair.
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